SEC Enforcement Action Focuses on Investment Adviser’s Proxy Voting Policies and Procedures

May 21, 2009

On May 7, 2009, the Securities and Exchange Commission settled charges against INTECH Investment Management, LLC, a registered investment adviser with over $55 billion in assets under management, and David E. Hurley, INTECH’s Chief Operating Officer and an Executive Vice President (http://www.sec.gov/litigation/admin/2009/ia-2872.pdf).  In particular, the SEC found that INTECH violated Advisers Act Section 206(4) and Rule 206(4)-6, and its COO aided and abetted such violation, because the investment adviser’s policies and procedures and its disclosures to clients did not address how to handle material potential conflicts of interest between INTECH and its clients in order to ensure that it would vote clients’ securities in their best interests.

Background

INTECH uses a third-party proxy voting service, Institutional Shareholder Services (“ISS”), to determine how to vote securities of clients who have delegated proxy voting authority to it.  After receiving inquiries and complaints from some of its union-affiliated clients about proxy votes that it had cast using ISS’s General Guidelines, which the SEC described as “typically recommending voting in accordance with corporations’ management’s recommendations”, INTECH switched to ISS’s Proxy Voter Services (“ISS-PVS”) Guidelines, which followed AFL-CIO voting recommendations.

According to the SEC’s Order, INTECH hoped that adopting the ISS-PVS Guidelines for all of its clients would improve its score on the annual AFL-CIO Key Votes Survey, which summarizes and ranks investment advisers based on their adherence to AFL-CIO recommendations.  INTECH believed that an improved score would  be helpful in maintaining existing and attracting new union-affiliated clients.  After switching to the ISS-PVS Guidelines, INTECH received inquiries from some clients as to why there seemed to be a higher number of votes against management. 

Summary of SEC’s Findings

The SEC found that INTECH had violated Rule 206(4)-6, the “Proxy Voting Rule," because its written policies and procedures did not: (1) address material potential conflicts that may have arisen between INTECH’s interests and those of its clients who were not pro-AFL-CIO; and (2) describe sufficiently to clients its proxy voting policies and procedures.  INTECH’s use of an AFL-CIO-based voting platform for all clients also resulted in a material potential conflict of interest because it did not address and describe the potential impact on INTECH’s ability to retain and obtain business from existing and prospective union-affiliated clients.

As COO, Mr. Hurley was responsible for evaluating whether certain proxy votes created conflicts between INTECH and its clients’ interests.  Although he participated in the drafting of INTECH’s proxy voting policies and procedures and client disclosures, including INTECH’s Form ADV, these documents did not disclose or address the potential conflicts of selecting the ISS-PVS platform, or describe the guidelines that were followed that resulted in proxy votes cast on behalf of clients.

Following the SEC staff’s inquiry, INTECH took several remedial actions, including:  (1) offering clients a choice between the union-related ISS-PVS Guidelines and the ISS-General Guidelines; (2) providing clients’ with a summary of the ISS-PVS Guidelines, which explained that the voting recommendations were based upon the AFL-CIO proxy voting recommendations, and (3) rather than defaulting to a particular ISS platform, defaulting to recommendations that best represented the client type.

INTECH and its COO settled with the SEC and, without admitting or denying the findings, consented to the entry of a cease-and desist-order and payment of civil monetary penalties of $300,000, and $50,000, respectively.

Advisers Act Rule 206(4)-6

An investment adviser is a fiduciary that is deemed to owe duties of care and loyalty to each of its clients. In the case of proxy voting, the SEC (http://www.sec.gov/rules/final/ia-2106.htm) interprets the duty of care to require the adviser to monitor corporate events and to vote proxies, and the duty of loyalty to require the adviser to vote proxies consistent with the best interests of its clients, even if at the expense of its own interests.

Rule 206(4)-6 requires an investment adviser that exercises voting authority over client proxies to:

• adopt policies and procedures reasonably designed to ensure that the adviser votes proxies in the best interests of clients,
• disclose to clients information about those policies and procedures, and
• disclose to clients how thy may obtain information on how the adviser has voted their proxies. 

Failure to comply with Rule 206(4)-6 is a fraudulent, deceptive, or manipulate act, practice or course of business under Section 206(4) of the Advisers Act.

Compliance Considerations

In light of the SEC’s enforcement action, we recommend that clients  review their policies and procedures and client disclosures in this area with the following in mind:

1. Review whether proxy voting policies and procedures address how the adviser will vote proxies on different matters, including changes in corporate governance structures, action involving compensation plans (including stock options and restricted stock awards), and matters involving corporate responsibility or social issues.  Alternatively, do the procedures identify the factors that will be considered?
2. Determine how material conflicts between the adviser’s interests and clients’ interests will be identified and addressed.
3. Assess whether written procedures and disclosures are consistent with actual practices.
4. Determine if different policies and procedures are required for different clients.
5. Confirm that responsible personnel have been identified to monitor and make voting decisions, and to ensure that proxies are voted and submitted timely.  If there have been personnel changes, determine whether any additional training is needed and if policies or procedures need to be updated.
6. Review disclosures to clients to ensure that they are current and accurate and reflect that different conflicts may arise for different clients.  Provide information so that clients can obtain additional information if desired.
7. If a third-party service is used to vote clients’ securities, (a) determine whether blanket reliance on the third party service is appropriate without any analysis of any or all votes, (b) disclose if, and to what extent, the adviser will rely on that service’s determinations, and include sufficient information about the third-party service’s proxy voting guidelines.
8. Confirm that clients’ receive disclosures regarding  all sub-advisers’ proxy voting procedures, if any.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you work or any of the following: 

Washington, D.C.
K. Susan Grafton (202-887-3554, [email protected])
Amy L. Goodman (202-955-8653, [email protected])
Barry R. Goldsmith (202-955-8580, [email protected])

New York
Edward D. Sopher (212-351-3918, [email protected])
Mark K. Schonfeld (212-351-2433, [email protected])

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.