ALI-ABA Course of Study Investment Company Regulation and Compliance July 16-18, 2008 Boston, Massachusetts

Transcription

1 443 ALI-ABA Course of Study Investment Company Regulation and Compliance July 16-18, 2008 Boston, Massachusetts Shareholder Meetings and Shareholder Voting By W. John McGuire Morgan, Lewis & Bockius LLP Washington, D.C.

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3 445 ALI-ABA Course of Study 2008 Investment Company Regulation and Compliance Conference I. INTRODUCTION SHAREHOLDER MEETINGS AND SHAREHOLDER VOTING W. John McGuire Morgan, Lewis & Bockius LLP 1/ Shareholder voting rights are governed by state statutes, proxy rules under the Investment Company Act of 1940, as amended (the 1940 Act), proxy rules under the Securities Exchange Act of 1934, as amended (the 1934 Act ), and by the investment company s charter documents (i.e., articles or declaration of trust, and bylaws). For investment companies organized as business trusts or statutory trusts, much procedural detail concerning shareholder voting will be in the charter documents. II. SHAREHOLDER VOTING RIGHTS UNDER STATE LAW When a question comes up about shareholder voting rights, the temptation is to turn immediately to the 1940 Act and the 1934 Act. But, the laws of the state where the investment company is organized should be the first authority used in determining many threshold issues, such as when shareholder meetings must be called, how much notice period is required and how votes can be cast (e.g., by telephone, internet, etc.). A. State Law Generally Controls Whether Annual Meetings are Required 1. Annual Meetings. State law generally requires annual meetings for investment companies organized in corporate form, but some states allow articles of incorporation to waive the annual meeting requirement. Jurisdictions that do not require annual meetings are the most popular choices for mutual funds. For example: a. Maryland - Registered investment companies organized as corporations in Maryland are not required to hold annual meetings, provided, the charter or bylaws so provide. b. Massachusetts and Delaware - Business or statutory trusts organized in these states are not required to hold annual meetings. 1 Portions of this outline are based on a previous ALI-ABA outline prepared by Julie Allecta, David Hearth and Nicole Gerrard of Paul, Hastings, Janofsky & Walker LLP and by Philip Newman and Edward O Dell of Goodwin Procter LLP. Shareholder Meetings and Voting

4 Special Meetings. If an investment company is not required to hold annual meeting pursuant to state law, the SEC requires the investment company to agree to certain shareholder rights (i.e., to hold a meeting to remove a director/trustee if requested to do so by holders of 10% of its shares). Because most investment companies seek out jurisdictions that do not require annual meetings, most mutual fund shareholder meetings are occasioned by special events such as changes in the ownership of the fund s investment adviser, or the need to elect new directors. Special meetings can also be called on the application of holders of 10% of the fund s voting shares. 3. Proxies. Virtually all votes at a shareholder meeting are not cast in person but are cast by proxies. Proxy voting procedures may be regulated in whole or part by state law. 4. Notice. Minimum notice is required for all shareholder meetings, although sometimes it can be waived. Generally, the permitted range is from a minimum of ten (10) days to a maximum of (90) days. 5. Record Date. Every meeting requires a record date the date used to determine ownership of shares and who is entitled to vote. Typically the record date is within sixty (60) days before a meeting. Forward Record Dates. Some states (but not Maryland) permit the use of a forward record date a record date that is after the initial proxy statement mailing date. A forward record date allows a fund to exclude shareholders who redeem after receiving notice of the proposed action and can sometimes be useful in getting the required vote. However, this procedure requires good systems to ensure that all shareholders eligible to vote receive a proxy in time to vote and that the votes of redeeming shareholders do not get counted. For business and statutory trusts, look for authorizing language in the declaration of trust. B. Listing Markets Can Require Annual Shareholder Meetings 1. National Securities Exchanges have corporate governance standards that apply to listed companies. 2. Listed Closed-end Funds typically have an annual shareholder meeting. 3. Exchange traded open-end funds and UITs, commonly called ETFs, do not typically have an annual shareholder meeting. 2 Shareholder Meetings and Voting

5 447 C. Corporate Actions Generally Requiring Shareholder Vote and Proxy Solicitation In general, governing state law, as well as the federal securities laws and the investment company s charter documents will dictate if a shareholder meeting is required for a corporate action. Changes affecting fundamental shareholder rights are more likely to require a shareholder meeting. Some examples of corporate actions generally requiring shareholder vote and proxy solicitation, are as follows: 1. Sale of substantially all the assets of the investment company. 2. Merger and reorganization of the investment company. 3. Dissolution Depending on the form of organization, some states may require a shareholder meeting to approve a liquidation or dissolution of the investment company. 4. Amendment Again, the need to convene a shareholder meeting for charter and by-law amendments depends on governing state law and the manner in which the investment company s charter documents are drafted. D. Miscellaneous 1. State laws typically differentiate between limited partnerships, corporations, business trusts and limited liability companies. Be sure you are looking at the right set of legal requirements. 2. Business trusts typically address many corporate requirements in their charter documents, and alter them as necessary to suit the specific investment company. 3. Some states (notably Maryland) require shareholder approval to increase the authorized number of shares and to effect certain recapitalizations such as reverse stock splits. III. SHAREHOLDER VOTING RIGHTS UNDER THE INVESTMENT COMPANY ACT While state law governs corporate actions and certain procedural matters, the 1940 Act is the primary source of requirements for shareholder meetings and proxy statements. For example: A. The Initial Approval of an Advisory Contract Requires a Shareholder Vote Section 15(a). 1. Under Section 15(a) of the 1940 Act, a majority of the fund s outstanding shares must approve the investment advisory contract when it is first put 3 Shareholder Meetings and Voting

6 448 into place. Initially, it must be approved for a period of at least two (2) years, after which it must be approved annually by either a majority of shares or the board of directors, and a majority of the independent directors. 2. Pursuant to the 1934 Act and as set forth in Schedule 14A, if any action is to be taken at a shareholders meeting with respect to an advisory (or subadvisory) contract, the mutual fund proxy must include specific information about the investment adviser and the proposed contract, including, to the extent applicable: a. Names and addresses of the investment adviser and any parent organizations or control persons of the investment adviser, and the basis of control of the investment adviser and each parent. b. Name, address and principal occupation of the investment adviser s principal executive officer, and each of its directors or general partners. c. Date of the advisory contract, and a description of the terms of the advisory contract, including the rate of compensation of the investment adviser. d. Last date on which the advisory contract was submitted to a vote of shareholders, and the purpose of such submission. e. Total fees paid to the investment adviser during the last fiscal year. f. Any other payments or benefits (including administrative fees, soft dollars, directed brokerage, etc.) to the investment adviser, or any affiliated person of the investment adviser, during the last fiscal year. g. If any person acts as an investment adviser to the fund other than pursuant to a written advisory contract approved by the shareholders, the identity of such person and a description of the services and arrangements. h. Any action taken by the board of directors/trustees with respect to the advisory contract since the beginning of the last fiscal year. i. If an advisory contract was terminated or not renewed, the date, circumstances and parties involved. j. Names of each officer or director/trustee of the fund who is also an officer, director, general partner, shareholder, affiliate or interested 4 Shareholder Meetings and Voting

7 449 party of the investment adviser, and a description of the nature of such interest or affiliation. k. Description and amount of any material direct or indirect interest of any director/trustee in any material transactions since the beginning of the last fiscal year, or material proposed transactions, with the investment adviser or its affiliates. l. Any financial condition of the investment adviser that is reasonably likely to impair its performance of the advisory contract. m. Nature of the action to be taken with respect to the advisory agreement at the shareholders meeting and the reasons therefor, and any material differences between the current and proposed advisory contracts. n. If the action is seeking a change in advisory fees, a comparison of fees before and after the change. o. If the investment adviser manages any other mutual fund with a similar investment objective, the identity and size of the other fund and the advisory fee rate, including any fee waivers. p. The material factors considered by board of directors/trustees in approving the advisory contract. The SEC requires the board to consider numerous specific factors, including, but not limited to, the following: (1) the nature, extent, and quality of the services to be provided by the investment adviser; (2) the investment performance of the fund and the investment adviser; (3) the costs of the services to be provided and profits to be realized by the investment adviser and its affiliates from the relationship with the fund; (4) the extent to which economies of scale would be realized as the fund grows; and (5) whether fee levels reflect these economies of scale for the benefit of fund investors. 2 q. Any arrangements made in connection with the advisory agreement with respect to the composition of the board of directors/trustees, the 2 Conclusory statements or a list of factors is not sufficient disclosure. The discussion must relate the factors to the specific circumstances of the fund and the investment advisory contract. See SEC Release No. IC (June 23, 2004) entitled "Disclosure Regarding Approval of Investment Advisory Contracts by Directors of Investment Companies." 5 Shareholder Meetings and Voting

8 450 investment adviser, or the officers of the fund or the investment adviser. r. The amounts of any commissions, and the percentage of the fund s total commissions, paid to brokers affiliated with the investment adviser during the last fiscal year. 3. The SEC has granted a series of exemptive orders allowing advisers to institute new sub-advisory arrangements with unaffiliated advisers without shareholder approval. In October 2003, the SEC issued a rule proposal that would effectively codify the type of relief granted by the exemptive orders. As of May 2007, the proposal had not been enacted. B. Change of Control in the Investment Adviser A change of ownership affecting the entity that serves as the investment adviser or a sale affecting ownership of the investment adviser s parent company may require shareholder vote if it constitutes a legal assignment. See 1940 Act Section 2(a)(4) and Rule 2a-6 thereunder. The SEC has issued numerous exemptive orders relieving funds of the need to conduct shareholder meetings in cases involving a change of control of a sub-adviser that is unaffiliated with the fund s adviser and sponsor and that is selected and monitored by the fund s adviser. C. Other Actions Requiring Shareholder Approval 1. Rule 12b-1 Once a Fund has made a public offering of its shares, majority of shares must approve any Rule 12b-1 distribution plan. 2. Section 32(a) The board of directors selects an independent accountant for the fund; however, if annual meetings are held, shareholders must vote at the annual meeting to ratify or reject the independent accountant. Rule 32a-4 under the 1940 Act exempts funds from the requirement to obtain shareholder approval of the selection of the fund s independent public accountants. This exemption is available if the fund has an audit committee overseeing the fund s accounting and auditing processes that is comprised wholly of independent directors, and the audit committee s structure, duties, powers and operations are set forth in an audit committee charter or the fund s charter or bylaws. Under rules enacted in January 2004, auditor engagements generally must also be approved by the audit committee. 6 Shareholder Meetings and Voting

9 Section 13(a) - To change classification from open-end to closed-end or from diversified to non-diversified. 4. Section 13(a)(2) -- To adopt policies to borrow money, issue senior securities, underwrite securities issued by others, purchase or sell real estate or commodities or make loans to others. 5. Section 13(a)(3). -- To act contrary to any fundamental policy or investment policy regarding concentration or changeable only by shareholder vote. 6. Section 13(a)(4). To change the nature of the fund s business so as to cease to be an investment company. D. Directors 1. Section 16(a) - Fund directors must be elected by shareholders. In general, at least one class of directors must be elected at each annual meeting if annual meetings are required. Between meetings or for funds that do not have annual meetings, vacancies may be filled by the board by appointment, subject to ratification by the shareholders at the next meeting. But, the 1940 Act limits the number of directors who can serve by appointment without shareholder ratification (i.e., without also having been elected by shareholders). After any appointment, at least two-thirds (2/3) of the directors must have been elected by shareholders. In addition, a special meeting must be called if vacancies or other circumstances lead to a situation where fewer than one-half (1/2) of the director spots are filled with directors who have been elected by shareholders. 2. Schedule 14A Pursuant to the 1934 Act, the proxy statement for the election of directors/trustees must include: a. Information about each director/trustee, nominee and executive officer, including: Name, age and address; Positions with the fund; Term of office and length of time served; Principal occupations during the past five years; Number of funds overseen (or to be overseen) by director/trustee; 7 Shareholder Meetings and Voting

10 452 Other directorships held by director/trustee; Positions held with fund affiliates; Dollar range of shares owned of fund, investment adviser, underwriter or affiliates; Arrangements or understandings pursuant to which such person has been or will be selected; Family relationships among such persons; Involvement in certain legal proceedings; Compensation and retirement benefits received from the fund or affiliates; Material transactions or proposed transactions with the fund in excess of $60,000, direct or indirect interest in investment adviser, underwriter or affiliates in excess of $60,000, certain relationships in excess of $60,000, and certain other potential conflicts of interest. b. Information about the board s meetings - number of meetings in previous year, and meetings of any committees. c. Information about the audit committee, including functions and members. d. Information about directors/trustees, officers and greater than 10% shareholders - whether there were any late Section 16 insider filings. e. Information about director attendance - name of any incumbent director/trustee who attended less than 75% of board and committee meetings (for which the director was a member). 3. Section 18 All securities issued by a mutual fund have equal voting rights with all other securities. But different series and classes may have distinct voting rights on matters affecting just that series or class. Rule 18f-2 under the 1940 Act provides specific guidance with respect to the separate voting requirements of a series company. Under Rule 18f-2, the various shareholder voting requirements of the 1940 Act for a series company may be satisfied on a series-by- 8 Shareholder Meetings and Voting

11 453 series basis. The separate voting requirements of a series company generally do not apply with respect to a vote for the selection of independent accountants, the election of directors, or the approval of a contract with the investment company s principal underwriter. IV. PROXY RULES FOR MUTUAL FUNDS A. Proxy Statements Must Comply with 1940 and 1934 Acts Proxy materials for any annual or special meeting must comply with 1940 Act and 1934 Act proxy rules. 3 In particular, the following 1934 Act rules are applicable: 1. Rule 14a-3. To solicit proxies, the fund must provide each shareholder with a proxy statement. 2. Rule 14a-4. Among other things, the proxy card must list separately each item requiring a shareholder vote, and provide boxes for disapproval or abstention. 3. Rule 14a-6. Preliminary proxy materials must be filed at least ten (10) days prior to being sent to shareholders. However, generally, more than ten (10) days is recommended. In certain situations, such as a merger, significantly more than ten (10) days should be allowed for SEC staff review. If the proxy only relates to certain routine matters, such as the election of directors, the approval of accountant or the continuation of investment advisory contracts, a fund need only file the definitive proxy statement at the same time as it is sent to shareholders. B. Additional Proxy Rules Proxy materials for any annual or special meeting must comply with 1940 Act and 1934 Act proxy rules. 4 In particular, the following 1934 Act rules are applicable: 1. Schedule 14A. Sets forth the information required to be in the proxy statement (Rule 20a-1 under the 1940 Act also contains requirements). 3 See Rule 20a-1 under the 1940 Act and Rules 14a-1 through 14b-2 under the 1934 Act, Schedule 14A (particularly Item 22) and Regulation S-K. See also Sections III.A and III.D.2 supra, regarding proxy statement disclosure for shareholder approval of advisory contracts and election of directors. 4 See Rule 20a-1 under the 1940 Act and Rules 14a-1 through 14b-2 under the 1934 Act, Schedule 14A (particularly Item 22) and Regulation S-K. See also Sections III.A and III.D.2 supra, regarding proxy statement disclosure for shareholder approval of advisory contracts and election of directors. 9 Shareholder Meetings and Voting

12 454 a. Schedule 14A requires the fund to notify shareholder of ability to revoke proxy. b. The proxy must always include: i. The identity of the solicitor (board of directors or others). ii. Who will pay for solicitation. iii. The means of solicitation, if any other than mail. iv. Amount spent/to be spent (only if proxy contest). v. Statement that the fund s annual report is available free of charge. 2. Rule 14a-9. False and misleading proxy statements are prohibited (1934 Act). 3. Form N-14. If a proxy statement relates to a merger and/or a reorganization, a fund typically mails shareholders a combined proxy statement and prospectus using Form N-14. Special rules apply to, and increased disclosure is required for, this combined registration statement and proxy statement. C. Item 22 Item 22 of Schedule 14A sets forth special requirements for investment company portfolios. These requirements have been amended several times in the past several years, most recently to require more information about important committees (especially the audit committee) and to require more information about fund directors when the election of directors is a proposal. See Sections III.A.1 and III.D.2 above. 1. Audit Committees. a. As a result of the Sarbanes-Oxley Act and related changes, the audit committee is given more attention in proxy statements. Funds must now state whether they have a separately designated audit committee (or whether the board of directors as a whole fulfills that function). There must also be disclosure regarding an exemption from applicable listing standards for audit committees. Other standing committees must also be identified. For all committees, information must be provided on function, membership and frequency of meeting. 10 Shareholder Meetings and Voting

13 Director Independence. a. Proxy rules now require more specific disclosure regarding directors and their independence. To quote from the SEC release (Release No. IC-24816, Jan. 2, 2001): We believe that shareholders have a significant interest in knowing who the independent directors are, whether the independent directors interests are aligned with shareholders interests, whether the independent directors have any conflicts of interest, and how the directors govern the fund. This information helps a mutual fund shareholder to evaluate whether the independent directors can, in fact, act as an independent, vigorous, and effective force in overseeing fund operations. b. The Release went on to conclude that there were several gaps in the information that shareholders currently receive about directors. The amendments were intended to close these gaps by requiring funds to provide: Basic information about directors to shareholders annually so that shareholders will know the identity and experience of their representatives; Disclosure of fund shares owned by directors to help shareholders evaluate whether directors interests are aligned with their own; Disclosure of information about directors that may raise conflict of interest concerns; and Information to shareholders on the board s role in governing the fund. c. The enhanced disclosure of conflicts of interest has required investment companies to ask a broader array of questions with respect to a broader array of entities. For directors who work in multimanager settings, the list of advisers and advisory affiliates can be quite extensive and directors need to consider various types of business relationships that may create technical or potential real conflicts. For many relationships, there is a de minimis disclosure threshold of $60,000. However, whether an interest is material, compromises director independence, or presents an actual or apparent conflict of interest is a fact-specific inquiry. 11 Shareholder Meetings and Voting

14 456 d. The 2001 requirements have significantly increased the type and scope of disclosure made about directors, including information about director compensation, fund share ownership, and considerations applied in the contract approval process. 3. Recent Developments. a. On January 22, 2007, the SEC adopted amendments to the proxy rules under the Securities Exchange Act of 1934 ( Exchange Act ) that allow, but do not require, issuers to furnish proxy materials to shareholders by posting them on an Internet website and providing shareholders with notice of the availability of the proxy materials. 5 Issuers and other soliciting persons may use the notice and access model beginning on July 1, Separately, in July 2007, the SEC adopted additional amendments to the proxy rules, which require issuers and other soliciting persons to use the notice and access model. 6 As adopted, the amendments would give all shareholders the ability to choose whether to receive proxy materials in paper form, via or via the Internet. Investment companies must comply after January 1, b. Under the new rules, an issuer may satisfy its obligation under the proxy rules to furnish proxy materials to shareholders in connection with a proxy solicitation by posting its proxy materials on a publiclyaccessible Internet website (other than the SEC s EDGAR website) and sending a Notice of Internet Availability of Proxy Materials ( Notice ). c. Some of the more significant aspects of the notice and access model are as follows: A Notice must be sent to shareholders at least 40 calendar days before the date of the shareholder meeting that indicates that the proxy materials are available and explains how to access those materials. 5 Final Rule: Internet Availability of Proxy Materials, Investment Company Act Rel. No (Jan. 22, 2007). 6 Final Rule: Universal Internet Availability of Proxy Materials, Investment Company Act Rel. No (July 26, 2007). 12 Shareholder Meetings and Voting

15 457 An issuer may not send a proxy card with the Notice, but may send a proxy card to shareholders 10 calendar days or more after sending the Notice. The Notice must contain certain information including how a shareholder can request a copy of the proxy materials, which must be sent within three business days of a request. An issuer may household the Notice pursuant to Rule 14a-3(e). An issuer must post the proxy card on the Internet website with the proxy statement and any annual report no later than the time at which the Notice is sent to shareholders. In addition, on the website, the issuer must concurrently provide shareholders with at least one method of executing a proxy vote, such as an electronic voting platform or a telephone number for executing a proxy. All proxy material furnished through the notice and access model, other than additional soliciting materials, must be posted on the Internet website by the time the issuer sends the Notice to shareholders through the conclusion of the shareholder meeting, at no charge to shareholders. Additional soliciting materials also must be posted to the website no later than the day on which the material is first sent to shareholders or made public. Shareholders and other persons conducting their own proxy solicitations also may rely on the notice and access model. However, unlike issuers, a soliciting person other than the issuer may selectively choose the shareholders from whom it desires to solicit proxies without the need to send an information statement to all other shareholders. d. Intermediaries also may use the notice and access method. An intermediary must prepare its own Notice for distribution to beneficial owners and must allow beneficial owners to elect to receive paper or e- mail copies of proxy materials. An intermediary s Notice sent to a beneficial owner should direct the owner to request paper or copies from his or her intermediary, rather than from the issuer. e. The intermediary may choose whether to direct beneficial owners to the issuer s website or to its own website to access the proxy materials. If it directs beneficial owners to the issuer s website, the 13 Shareholder Meetings and Voting

16 458 intermediary must inform beneficial owners that they can submit voting instructions to the intermediary, but cannot execute a proxy directly in favor of the issuer unless the intermediary has executed a proxy in favor of the beneficial owner. D. A Checklist of Other Considerations 1. A fund must ensure that nominees (e.g., brokerages like Smith, Barney or Charles Schwab, or banks) having shares registered in their name will forward the proxy material to beneficial owners. These intermediary nominees need advance notice for proxy solicitations. 2. A proxy statement used to solicit votes on different proposals from shareholders of more than one fund or class of shares must include a table at the beginning of the proxy statement summarizing each proposal and indicating which shareholders are being asked to approve each proposal. 3. A proxy statement relating to the election of directors must include a table setting forth the amount of compensation a director or trustee received (including any pension or retirement benefits accrued) for the fund s last fiscal year. The table must also disclose the aggregate compensation received by a director from all funds in the same fund complex. 4. If action is being taken to increase or establish a new fee or expense, the proxy statement must include a table showing the current and pro forma fees. 5. If action is being taken to approve an advisory contract, the proxy statement must include a discussion of the material factors considered by the directors in recommending the advisory contract for approval, including a discussion of any soft-dollar arrangements that benefit the investment adviser. 6. Under Rule 30e-1 of the 1940 Act, a fund is required to transmit semiannually to shareholders of record, within 60 days after the end of the fiscal period, a report containing the financial statements required to be included in such report by the fund s registration statement form (i.e., Item 22(b)(1) and 22(c)(1) of Form N-1A; Item 24, instructions 4 and 5, of Form N-2; or Item 28(a), instructions 4 and 5, of Form N-3). Unless a proxy statement is accompanied by such a report, the proxy statement must include a statement that the fund s most recent annual report and semiannual report, if any, are available upon request and without charge. The proxy statement must provide the address (including title and department) and telephone number to which such requests should be directed. The report must be provided by first-class mail or another means designated to assure prompt delivery within one (1) business day of the request. 14 Shareholder Meetings and Voting

17 459 E. Electronic Shareholder Forums In January 2008, by a unanimous vote, the SEC approved rules that are designed to facilitate greater Internet communication among shareholders and companies. Rule 14a-18(a) permits a company or a shareholder to operate an electronic shareholder forum without being subject to liability for any information or statements posted on that forum. The company or shareholder operating the forum will continue to be subject to compliance with the federal securities laws, including the antifraud rules. Rule 14a-2(b)(6) exempts certain types of solicitations from the limitations set forth in Regulation 14A on the types of public activities a shareholder or company may engage in when discussing issues that may be voted on at a company s shareholder meeting. Specifically, any solicitation in an electronic shareholder forum by or on behalf of any person who does not seek the power to act as a proxy for a shareholder and does not furnish or request a form of revocation, abstention, consent, or authorization would be exempt. To be exempt, such solicitation must occur more than 60 days before an annual or special meeting or within two days of the announcement of the meeting. The SEC emphasized that Rule 14a-2(b)(6) was not intended to replace the ability of a person to engage in the current proxy solicitation process of Regulation 14A, but to be an addition to that process V. MECHANICS OF SHAREHOLDER MEETING A. The board sets the date of meeting and record date, but frequently delegates the specific date selection to management. B. Timing 1. Notice and inquiry to brokers, banks and other financial intermediaries initiate as soon as possible 2. Preparation of proxy statement 5 to 10 days, plus review time needed 3. Submission -- to SEC, minimum 10 days (see Section IV.A.3) 4. Printing and Mailing 5 to 15 days 5. Solicitation generally allow 30 to 45 days; 60 days may be necessary C. Required Vote 1. Different proposals require different levels of shareholder vote. For example, some investment companies, by charter or state law, have basic quorum requirements as low as 40% and basic actions can be approved by 50% of voted shares if a quorum is present; this theoretically would allow 15 Shareholder Meetings and Voting

18 460 21% of actual shares to approve a basic action like the election of a director. 2. For some actions, the 1940 Act requirement, set forth in Section 2(a)(42), pertains. This requirement can be satisfied by obtaining the vote of either: D. Broker Non-Votes a. 67% or more of the voting securities present at such meeting, if the holders of more than 50% of the outstanding voting securities of such company are present or represented by proxy; or b. More than 50% of the outstanding voting securities of such company. 1. Many mutual fund shares are held in street name by brokers, banks and other financial intermediaries. If the intermediary does not receive instructions on how to vote the underlying owner s shares on a routine matter, the intermediary may be able to exercise its discretion and vote the shares itself, or at least present the shares for purposes of establishing a quorum. The proxy statement should specify how these shares will be considered. For example, if these shares count for purposes of the quorum, do they also count in determining whether more than 50% of the shares are present or whether at least 67% of the shares present have voted in favor of a proposal (the 1940 Act Section 2(a)(42) standard)? These issues should be considered in advance and the procedure for counting intermediary-tendered shares stated clearly in the proxy statement along with the percentage of votes required for each proposal s approval. 2. NYSE rules permit brokers to vote on routine matters for customers who do not respond provided that the proxy statements are sent to the broker s customer sufficiently in advance of the meeting date. Late notification of the proxy solicitation to the intermediary broker may prevent the broker from submitting a broker non-vote. 3. The NYSE has filed a proposed rule change with the SEC to eliminate broker discretionary voting for board of director elections. 7 The proposal follows recommendations of the Proxy Working Group ( PWG ), which 7 The proposed rule change is available at Report and Recommendations of the Proxy Working Group to the New York Stock Exchange (June 5, 2006) available at 16 Shareholder Meetings and Voting

19 461 was created in April 2005 by the NYSE to review the proxy voting process. The proposed amendment would apply to shareholder meetings held on or after January 1, 2008, except to the extent that a meeting was originally scheduled to be held in 2007 but was adjourned to A significant effect of the proposed rule change is that broker votes of uninstructed shares for elections of directors would no longer be permitted to be used in establishing a quorum at shareholder meetings. In June 2007, the Investment Company Institute reported that the NYSE has submitted a revised proposed rule change to the SEC that exempts mutual funds from the proposal. VI. SHAREHOLDER PROPOSALS A. Rule 14a-8 under the 1934 Act -- Shareholder Proposals From time to time shareholders may petition the fund to include a shareholderoriginated proposal in the next proxy. To facilitate this form of shareholder initiative, every proxy statement must advise shareholders of the procedure. If a shareholder gives timely notice to fund management before a shareholder meeting of an acceptable proposal, the fund must include the proposal for action in the proxy statement issued in anticipation of the meeting. 1. Notice. Shareholders must notify a fund of the proposal no less than 120 days before the annual meeting (or a reasonable time before a special meeting). 2. Shareholder Requirements. The shareholder must be record/beneficial owner of $2,000+ of fund securities for at least one year before submission. 3. Omission of Proposals. The fund may omit proposals relating to routine business matters, the ordinary conduct of the fund, actions not a proper subject of shareholder action, and personal grievances. A shareholder may submit only one proposal per meeting. 4. Recent Developments. In December 2007, by a vote of 3-1 (Commissioner Nazareth voted against), the SEC voted to approve amendments to Rule 14a-8(i)(8) to clarify its exclusion for shareholder proposals on the election of directors. Rule 14a-8(i)(8) provides that a company may exclude a shareholder proposal that relates to an election for membership on the company s board of directors or analogous governing body. In interpreting Rule 14a-8(i)(8), the SEC staff had permitted companies to exclude shareholder proposals that would result in a contested election, including any change to the nominee procedures. The purpose of this position is to prevent Rule 14a-8 from being used to conduct election campaigns. The SEC s clarification is a result of a recent 17 Shareholder Meetings and Voting

20 462 Second Circuit decision in American Federation of State, County & Municipal Employees, Employees Pension Plan v. American International Group, Inc., 462 F.3d 121 (2d Cir. 2006), which held that AIG could not rely on Rule 14a-8(i)(8) to exclude a shareholder proposal seeking to amend a company s bylaws to establish a procedure whereby shareholder nominees for director would be included in AIG s proxy materials. The SEC has taken the position that Rule 14a-8(i)(8) should not be interpreted to permit such proposals. Citing the uncertainty created by the AIG case, the SEC has amended the exclusion in Rule 14a-8(i)(8) as follows: If the proposal relates to a nomination or an election for membership on the company s board of directors or analogous governing body or a procedure for such nomination or election (emphasis added).. VII. ELECTRONIC PROXY VOTING A. Benefits The staff of the SEC will not object to proxy solicitation materials containing a supplemental method for shareholders to vote electronically by using a telephonic or other electronic voting system, if specifically permitted by applicable state law and if certain other conditions are met. See 1996 Generic Comment Letter (Feb. 15, 1996). Telephone and fax responses have been in use for some time. The latest development is on-line voting. The benefits of this are twofold: proxy tabulation is dramatically less expensive when votes are received electronically, and more shareholders are likely to respond to a proxy solicitation if given more options on how to respond. B. Forms Currently, electronic proxy voting takes two different forms. 1. Telephone voting. It is common for funds to allow shareholders to use the telephone to dial-in their votes. Usually, a fund will provide a toll free number for shareholders to call. On calling, shareholders enter a PIN number printed on their proxy card, and are then prompted to enter their vote. 2. Internet voting. Internet voting is preferred by shareholders who use the internet. Under the typical process, shareholders with internet access can log-on to their internet service provider, access their browser, and enter a URL address printed on their proxy card. They are then prompted to enter a password, after which they may enter their vote. C. Legal Issues 18 Shareholder Meetings and Voting

21 463 While the SEC has stated that it will not object to electronic voting as a supplement to voting by mail, funds should still: 1. Confirm that the relevant state allows shareholder to vote electronically (i.e., electronic voting is statutorily permitted in Delaware and Maryland). 2. Confirm that the fund s articles and bylaws allow for electronic voting. Drafting tip incorporate in the fund s declaration of trust explicit authorization to convene meetings, vote and carry on other business electronically if the investment company is organized in a liberal jurisdiction with a modern statutory trust statute like Delaware. VIII. ADJOURNMENTS OF SHAREHOLDER MEETINGS A. On several occasions, the SEC has expressed its concern with management s practice of adjourning a shareholder meeting, notwithstanding the presence of a quorum under state law, in an effort to gain sufficient additional votes to approve certain proposals. B. In 1972, the SEC proposed Rule 20a-4 to address these concerns. 8 Rule 20a-4, as proposed, would have prohibited the adjournment of a meeting of shareholders at which a quorum under state or applicable law, or corporate charter or other instrument pursuant to such law, is present in person or by proxy, for the purpose of soliciting additional proxies in the event that there are insufficient votes pursuant to the 1940 Act to approve a proposal recommended by management. C. The SEC subsequently withdrew the proposed Rule 20a-4 in In its withdrawing release, the SEC stated that such withdrawal should not be construed as an abatement of the SEC s concern with the problem of unwarranted adjournment of investment company shareholder meetings or resolicitation of shareholders. The SEC went on to state: Investment company management must weigh carefully the decision whether to adjourn a shareholder meeting for the purpose of soliciting shareholders to obtain additional proxies in an effort to secure sufficient votes to pass a particular proposal or proposals. In any case their shareholders clearly express their disagreement and disinterest in a proposal through negative votes or abstention, 8 See Investment Company Act Release No (Mar. 21, 1972). 9 See Investment Company Act Release No (Feb. 6, 1973). 19 Shareholder Meetings and Voting

22 464 and thus fail to yield sufficient votes for passage, management must determine if an adjournment and additional solicitation is reasonable and in the interest of shareholders, or whether such procedures would constitute an abuse of management s office. Where management embarks upon a course of adjournment and additional solicitation, the SEC will consider whether such conduct appears to constitute a breach of fiduciary duty under Section 36(a) of the [1940] Act. Among the factors the SEC will consider will be the nature of the proposal, the percentage of votes actually cast, the percentage of actual negative votes, the nature of the further solicitation and the information provided to shareholders with respect to the reasons for such further solicitation. D. To minimize the risks associated with adjourning a meeting to a later date, a fund should disclose in its proxy statement that, if insufficient votes are available for approval of any matter, the proxies intend to propose one or more adjournments of the meeting to permit additional time for the solicitation of proxies. The proxy statement should also disclose the manner in which shares represented by proxy will be voted on such an adjournment proposal. For example, the proxy statement might disclose that all proxies received with instructions to vote in favor of the underlying proposal and all proxies received without voting instructions will be voted in favor of the adjournment proposal, all proxies received with instructions to vote against the underlying proposal will be voted against the adjournment proposal, and all proxies received with instruction to abstain from voting on the underlying proposal will abstain from voting on the adjournment proposal. IX. FINAL NOTES A. Prepare a Script Prepare a script of the meeting that can be readily completed and turned into minutes of the shareholder meeting. B. Appearances 1. Very few shareholders ever attend mutual fund shareholder meetings unless an effort is made to invite them. Nevertheless, be prepared for an occasional shareholder to appear in person. a. Have a script ready. b. Designate individuals from the management company or fund officers to serve as the chairperson, inspector of election, secretary, etc. Check charter documents for limitations. Generally, affiliation is 20 Shareholder Meetings and Voting

23 465 not a bar to serving in any position, but one person should not serve in all capacities. c. Proxies can be revoked by a shareholder appearing in person and his/her/its vote recast in person. If this is done, remember to retabulate the vote. 2. Directors, auditors and fund representatives need be present only if the proxy statement states that they will be present. Good practice suggests adding a line to the proxy statement that no fund representatives will be present if there is no intention to have any of these persons at the meeting. C. Report the Results Rule 30b1-4 requires the fund to report the results of the vote in the next annual or semi-annual report to shareholders. The board of directors should be advised promptly. Form N-SAR requires reporting on shareholder meetings. X. SPECIAL CONSIDERATIONS FOR INSURANCE PRODUCT FUNDING VEHICLES A. Mutual funds that serve as the funding media for insurance products raise certain special considerations. The record owner of underlying fund shares is the separate account of the insurance company. In fact, under state insurance laws, the assets of an insurance company s separate account are owned by the insurance company. Pursuant to an interpretation of SEC staff and incorporation of the interpretation into certain rules applicable to variable insurance products, owners of the variable insurance products are entitled to pass-through voting privileges. (See also Section 12(d)(1)(E) of the 1940 Act). The insurance company is required to seek voting instructions from the owners. Moreover, the insurance company is required to vote shares for which it receives no instructions in the same proportion as the shares for which it did receive instructions. Finally, the insurance company also is required to vote shares that it holds in its own right in those same proportions. B. Underlying fund voting is further complicated by the conditions imposed by Rules 6e-2 and 6e-3(T) of the 1940 Act. As a condition to permitting the same fund to serve as the funding media for both variable annuities and variable life insurance, voting must be conducted and calculated in the same manner by all insurance companies whose separate accounts invest in a fund. The terms of these similar voting requirements are generally memorialized in the agreements that the separate accounts and funds enter into to govern various aspects of their relationship. These agreements have come to be known as Participation Agreements. 21 Shareholder Meetings and Voting

24 466 2