Mutual Funds, Management Support, and Fiduciary Obligations

Shareholder proposals challenging excessive compensation practices often fail.  One would think that in general, shareholders are not overly concerned with these practices.  Yet the public outcry belies that notion.  What explains, then, this lack of success?

One answer has been provided by AFSCME.  In a study, it shows that mutual funds almost always support management when it comes to proposals on executive compensation.  According to the study:

• The average level of support for management proposals on compensation issues was 82% in 2007 and 84% in 2008, a steady increase from 75.8% in 2006.

• The average level of support for the categories of compensation-related shareholder proposals we selected was 42% in 2007 and 40% in 2008. This represents a significant decrease from the 46.5% support found in 2006.

The data, therefore, suggests rote support.  Needless to say, mutual funds are not insignificant investors.  The study disclosed that these funds hold about "27 percent of the market capitalization of all U.S. companies."  In many cases, therefore, the voting practice is likely to be outcome determinative.

This information is only available because of the stance taken by the Commission in 2003 to require the disclosure of voting practices by mutual funds (see Item 12(f) of Form N-1A).  This requirement was vigerously opposed by broad swathes of the industry. 

The AFSCME Study makes a number of recommendations (see p. 5). We add one more.  Perhaps its time for the SEC to go beyond mere disclosure.  While the Exchange Act limits the agency to disclosure (see Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure), the Investment Company Act of 1940 is not so limited.  Under Section 36(a), the Agency can bring actions for violations of fiduciary duties by the board.  Moreover, under Section 38, the SEC has broad rulemaking authority.  Perhaps it is time to either gear up an enforcement program or consider a rule that would force boards of mutual funds to justify their voting behavior.