Alert May 19, 2009

SEC Settles Administrative Proceeding with Investment Adviser and its former COO over Use of Third-Party Proxy Voting Service

The SEC settled administrative proceedings with a registered investment adviser (the “Adviser”) and the Adviser’s former chief operating officer (the “COO”) over the Adviser’s use of a third-party proxy voting guidelines in its proxy voting procedures, which the SEC found had not complied with paragraphs (a) and (c) of Rule 206(4)-6 under the Investment Advisers Act of 1940.  Rule 206(4)-6(a) requires an adviser’s written policy for proxy voting to address material conflicts of interest that may arise between the investment adviser’s interests and those of its clients.  Rule 206(4)-6(c) requires an adviser to provide its clients with a description of its proxy voting policy.

The Adviser’s Choice of Proxy Voting Service.  According to the SEC findings, in deciding how to vote client securities the Adviser chose to rely upon the recommendations of Institutional Shareholder Services (“ISS”), a third-party proxy voting service.  After several months of using the ISS‑General Guidelines, the Adviser switched to the ISS‑PVS Guidelines, which followed the voting recommendations of the AFL‑CIO.  According to the SEC settlement order, the Adviser believed this change could improve its score on the AFL‑CIO Key Votes Survey (the “AFL‑CIO Survey”), a survey that placed investment advisers into one of three tiers based upon the percentage of votes the advisers cast that were consistent with AFL-CIO voting recommendations on key voting issues.  The order also states that union‑affiliated clients had communicated displeasure with some of the Adviser’s votes made while the Adviser used the ISS‑General Guidelines, and that the Adviser believed other prospective union-affiliated clients might use the AFL-CIO Survey as a factor in selecting an investment adviser.  The Adviser also believed that the ISS-PVS Guidelines applied a reasonable standard for enhancing shareholder value as it related to corporate governance matters. 

Violations of Rule 206(4)-6.  The SEC found that the Adviser violated Rule 206(4)-6(a) because the Adviser’s proxy voting policies failed to address its potential conflict of interest in following the ISS-PVS Guidelines for all clients while the Adviser sought to attract union-affiliated clients. The SEC also found that the Adviser failed to adequately describe its proxy voting policies and procedures to clients in violation of Rule 206(4)-6(c) because the Adviser failed to disclose that the ISS-PVS Guidelines followed AFL-CIO voting recommendations.  In addition, the policies and procedures sent to clients indicated that the Adviser did not expect any conflicts of interest to arise under the proxy voting policies and procedures because the Adviser used a third party proxy voting service.   The COO reviewed and edited counsel’s drafts of the proxy voting policies and procedures, and executed the cover letter accompanying the policies and procedures sent to clients, which also indicated that use of a third party voting services was expected to prevent any conflicts from arising.  The SEC found that in his capacity as such, the COO had a duty to evaluate whether the procedures created conflicts of interest between the Adviser’s and its clients’ interests.  The COO was found to have willfully aided and abetted and caused the Adviser’s violations of Rule 206(4)-6.

Subsequent Changes to Proxy Voting Policies.  The SEC order describes the Adviser’s subsequent revisions to its procedures to bring them into compliance with Rule 206(4)-6.  The Adviser disclosed to its clients that the Adviser had chosen as its standard voting policy third party voting guidelines based on AFL-CIO voting recommendations and that this choice could result in the Adviser retaining and obtaining Taft‑Hartley or other union-affiliated clients.  The Adviser also offered clients the choice of voting proxies pursuant to ISS guidelines that were more management-friendly.  In addition, “although not required by [Rule 206(4)-6],” the Adviser subsequently allowed clients to choose from several voting recommendations.  The Adviser also changed its default voting policy from the ISS‑PVS Guidelines to recommendations based on client type.

Penalties.  Under the settlement, the Adviser must pay a $300,000 civil money penalty and the CCO must pay a $50,000 civil money penalty.