[Federal Register Volume 67, Number 187 (Thursday, September 26, 2002)]
[Proposed Rules]
[Pages 60841-60851]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-24410]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release No. IA-2059; File No. S7-38-02]
RIN 3235-AI65


Proxy Voting By Investment Advisers

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Commission is publishing for comment a new rule and rule 
amendments under the Investment Advisers Act of 1940 that would address 
an investment adviser's fiduciary obligation to clients who have given 
the adviser authority to vote their proxies. Under our proposal, an 
investment adviser that exercises voting authority over client proxies 
would be required to adopt and implement policies and procedures that 
are reasonably designed to ensure that the adviser votes proxies in the 
best interest of clients, disclose to clients information about those 
procedures and policies and how clients may obtain information on how 
the adviser has voted their proxies, and retain certain records 
relating to proxy voting. The rule and rule amendments are designed to 
assure that advisers vote proxies in the best interest of their clients 
and provide clients with information about how their proxies are voted.

DATES: Comments must be received on or before December 6, 2002.

ADDRESSES: To help us process and review your comments more 
efficiently, comments should be sent by hard copy or e-mail, but not by 
both methods.
    Comments sent by hardcopy should be submitted in triplicate to 
Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 
Fifth Street, NW., Washington, DC 20549-0609. Comments may also be 
submitted electronically at the following e-mail address: [email protected]. All comment letters should refer to File No. S7-38-
02; if e-mail is used, this file number should be included on the 
subject line. Comment letters will be available for public inspection 
and copying in the Commission's Public Reference Room, 450 Fifth 
Street, NW., Washington, DC 20549. Electronically submitted comment 
letters also will be posted on the Commission's Internet Web site 
(http://www.sec.gov).\1\
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    \1\ We do not edit personal or identifying information, such as 
names or E-mail addresses, from electronic submissions. Submit only 
information you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: Daniel S. Kahl, Senior Counsel, or 
Jamey Basham, Special Counsel, at 202-942-0719, Office of Investment 
Adviser Regulation, Division of Investment Management, Securities and 
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Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0506.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'' or ``SEC'') is requesting public comment on proposed 
rule 206(4)-6 [17 CFR 275.206(4)-6] and proposed amendments to rule 
204-2 [17 CFR 275.204-2] under the Investment Advisers Act of 1940 [15 
U.S.C. 80b] (``Advisers Act'' or ``Act'').

I. Background

    Investment advisers today have discretionary investment authority 
with respect to almost $19 trillion dollars of assets, including large 
holdings in equity securities.\2\ In most cases, these

[[Page 60842]]

advisers are given authority to vote proxies relating to equity 
securities on behalf of their clients.\3\ The enormity of this voting 
power gives advisers significant ability collectively, and in many 
cases individually, to affect the outcome of shareholder votes and to 
substantially influence the governance of corporations.\4\ Advisers are 
thus in a position to have a significant effect on the future of 
corporations and the value of securities held by advisory clients.
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    \2\ Approximately $7 trillion of these assets are held by mutual 
funds. In a companion release, we are also publishing proposed 
amendments that would require mutual funds to disclose policies and 
procedures they use to vote proxies on their portfolio securities, 
and to make available to their shareholders the specific proxy votes 
they cast. See Disclosure of Proxy Voting Policies and Proxy Voting 
Records by Registered Management Investment Companies, Investment 
Company Act Release No. 25739 (Sept. 20, 2002).
    \3\ In the mid 1990s, the Commission approved rule changes 
submitted by the New York Stock Exchange, the National Association 
of Securities Dealers, Inc., and the American Stock Exchange to 
allow investment advisers to receive proxy materials and to vote 
proxies on behalf of the beneficial owners of securities. See, e.g., 
Order Approving Proposed Rule Changes by the NASD, Securities 
Exchange Act Release No. 35681 (May 5, 1995) [60 FR 25749 (May 12, 
1995)].
    \4\ See generally Board of Governors of the Federal Reserve 
System, Flow of Funds Accounts of the U.S., Flows and Outstandings, 
First Quarter 2002 (June 6, 2002) (at table L. 213) (data indicate 
institutional investors control approximately 50% of the outstanding 
corporate equities in the United States); A. A. Sommer, Jr., 
Symposium: Defining the Corporate Constituency: Corporate Governance 
in the Nineties: Managers vs. Institutions, 59 U. Cin. L. Rev. 357 
(Fall 1990) (discussing the ``profound'' effects of institutional 
ownership and the inevitable influence it will have on management 
conduct, the laws governing corporations and fiduciaries, and the 
American economy); Beth Healy, Big Investors Assuming a More 
Activist Stance, The Boston Globe, July 11, 2002, at C1 (discussing 
an activist stance by several large institutional investors on 
corporate governance issues).
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    The federal securities laws do not specifically address how 
advisers must exercise their voting authority. Under the Advisers Act, 
an investment adviser is, however, a fiduciary that owes its clients a 
duty of ``utmost good faith, and full and fair disclosure of all 
material facts,'' as well as an affirmative obligation ``to employ 
reasonable care to avoid misleading'' its clients.\5\ An adviser owes 
its client a fiduciary duty with respect to all services undertaken on 
the client's behalf, including the voting of proxies.\6\ An adviser's 
fiduciary duty includes the duty of care and the duty of loyalty to 
clients. The duty of care requires an adviser given authority to vote 
proxies to monitor corporate events and to vote the proxies.\7\ The 
duty of loyalty requires an adviser to vote proxies in a manner 
consistent with the best interest of its client and precludes the 
adviser from subrogating the client's interest to its own.\8\
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    \5\ SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 
194 (1963) (interpreting section 206 of the Advisers Act [15 U.S.C. 
80b-6]).
    \6\ Unlike the anti-fraud provisions in other provisions of the 
federal securities laws, section 206 is not limited to fraud in 
connection with securities transactions. The relevant provisions of 
section 206 do not refer to dealings in securities, but are stated 
in terms of the effect of the prohibited conduct on clients. 
Sections 206(1), 206(2), and 206(4) [15 U.S.C. 80b-6(1), 80b-6(2), 
80b6-(4)].
    \7\ We do not mean to suggest, however, that an adviser that 
fails to vote a proxy would thereby violate its fiduciary 
obligations to its client under the Act. There may be good reasons 
for an adviser to refrain from voting a proxy when, for example, the 
cost of voting the proxy exceeds the expected benefit. An adviser 
may not, however, ignore or be negligent in fulfilling the 
obligation it has assumed to vote client proxies.
    \8\ The scope of the adviser's responsibilities with respect to 
voting proxies would ordinarily be determined by the adviser's 
contract with its client, and the investment objectives and policies 
of its client. We are not addressing in this release the extent to 
which advisers must or should become ``shareholder activists,'' such 
as actively engaging in soliciting proxies or supporting or opposing 
matters before shareholders. As a practical matter, advisers will 
determine whether to engage in such activism based on a cost-benefit 
analysis of the considered activism. See Robert C. Pozen, 
Institutional Investors: The Reluctant Activists, Harv. Bus. Rev., 
Jan.-Feb. 1994, at 140. In conducting this analysis, the adviser 
might consider the size of the client's position in the company, the 
nature of the action proposed to be taken, the cost of the 
particular course of action, and the probable effect of the proposed 
action, if any, on the value of the client's securities.
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    The Commission is concerned with conflicts of interest between 
advisers and their clients. Advisers today frequently have business 
interests that may expose them to pressure to vote in a manner that may 
not be in the best interest of their clients.\9\ Many advisers (or 
their affiliates) manage assets, administer employee benefit plans, or 
provide brokerage, underwriting, insurance, or banking services to 
companies whose management is soliciting proxies. Failure to vote 
proxies in favor of the management of such a company may harm the 
adviser's relationship with the company, particularly when there is a 
contested matter before shareholders. In some cases, the adviser may 
have a business relationship, not with the company, but with a 
proponent of a proxy proposal, that may affect how it casts client 
votes. For example, the adviser may manage money for an employee group.
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    \9\ See Employee Benefit Research Institute Issue Brief, Voting 
Private Pension Proxies: Some New Evidence and Some Old Questions, 
(Sept. 1987) (No. 70 at 21) (reporting 65% of investment managers 
surveyed experienced direct or indirect pressure regarding proxy 
voting).
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    Other types of conflicts may affect how advisers vote client 
proxies. The adviser may have personal and business relationships with 
participants in proxy contests, corporate directors or candidates for 
corporate directorships, or the adviser may have a personal interest in 
the outcome of a particular matter before shareholders. For example, an 
executive of the adviser may have a spouse or other relative who serves 
as a director of a company or who is employed by the company.
    These conflicts are not new. We described them in detail in our 
1971 report to Congress on Institutional Investors.\10\ In 2000, we 
expressed concern about these conflicts and proposed to require 
advisers to disclose to clients the policies that they had in place, if 
any, to address these conflicts.\11\ The Department of Labor has 
recognized that they can adversely affect the management of employee 
benefit plans.\12\
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    \10\ U.S. Securities and Exchange Commission, Institutional 
Investor Study Report of the Securities and Exchange Commission, in 
H.R. Doc. No. 92-64, Part 5.E. at 2749-2763; See also Betty Linn 
Krikorian, Fiduciary Standards in Pension and Trust Fund Management 
(1989), at 210-219; James E. Heard and Howard D. Sherman, Investor 
Responsibility Research Center, Conflicts of Interest in the Proxy 
Voting System (1987).
    \11\ Electronic Filing by Investment Advisers; Proposed 
Amendments to Form ADV, Investment Advisers Act Release No. 1862 
(Apr. 5, 2000) [65 FR 20524 (Apr. 17, 2000)] at n. 192. In addition, 
former Commissioner Carey highlighted similar concerns about proxy 
voting by advisers in a December 1999 speech; Paul R. Carey, Remarks 
to the Investment Company Institute Procedures Conference (Dec. 9, 
1999), (available at <http://www.sec.gov/news/speech/speecharchive/1999/spch335.htm).
    \12\ Department of Labor, Interpretive Bulletin Relating to 
Written Statements of Investment Policy, Including Proxy Voting 
Guidelines, 29 CFR 2509.94-2 (2001) (``DOL Interp. Bulletin''). The 
bulletin states that under the Employee Retirement Income Security 
Act of 1974 [29 U.S.C. 1001, et. seq.] (``ERISA'') the fiduciary act 
of managing ERISA assets includes the voting of proxies, and in 
voting those proxies the fiduciary may only consider the best 
interest of plan participants. Many investment advisers are 
``investment managers,'' that are delegated authority to manage plan 
assets and vote plan proxies under ERISA. When managing plan assets 
and voting proxies, advisers are also subject to the fiduciary 
standards of ERISA.
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    Under the Act, an adviser with a material conflict of interest must 
fully disclose that conflict to its client before voting the client's 
proxy. Many advisers, instead, have adopted policies and procedures 
that are designed to ensure that client proxies are properly voted, 
material conflicts are avoided, and fiduciary obligations are otherwise 
fulfilled.\13\ Not all advisers have these procedures in place, not all 
advisers that have procedures make them available to their clients, and 
not all advisers that vote client proxies make the votes available to 
clients. The importance of proxy voting by investment advisers--both to 
their clients and to our system of corporate governance--as well as the

[[Page 60843]]

many conflicts faced by advisers suggest a need for the Commission to 
address proxy voting by investment advisers under the Advisers Act. 
Therefore, the Commission is proposing a new rule under the Advisers 
Act designed to prevent material conflicts of interest from affecting 
the manner in which advisers vote client proxies.
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    \13\ See generally Association for Investment Management and 
Research, Standards of Practice Handbook, The Code of Ethics and The 
Standards of Professional Conduct (1999) (Eighth Edition at 161) 
(discussing elements of a proxy voting system to allow investment 
advisers to meet their fiduciary obligation when voting proxies).
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II. Discussion

    We propose a new rule under section 206(4) of the Act that would 
require certain advisers to adopt and implement procedures for voting 
proxies, describe those procedures to their clients, and disclose how 
clients may obtain information about how the adviser has voted proxies. 
We are also proposing amendments to rule 204-2 under the Advisers Act 
to require advisers to keep certain records regarding their proxy votes 
on behalf of clients.

A. Rule 206(4)-6

    Under proposed rule 206(4)-6, it would be a fraudulent, deceptive, 
or manipulative act, practice or course of business within the meaning 
of section 206(4) of the Act for an investment adviser to exercise 
voting authority with respect to client securities, unless: the adviser 
has adopted and implements written policies and procedures that are 
reasonably designed to ensure that the adviser votes proxies in the 
best interest of its clients, the adviser discloses to clients how they 
may obtain information on how the adviser voted their proxies, and the 
adviser has disclosed its proxy voting procedures to its clients.\14\ 
We describe each of the elements of the rule below.\15\
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    \14\ Section 206(4) of the Act [15 U.S.C. 80b-6(4)] gives the 
Commission authority to adopt rules ``reasonably designed to prevent 
such acts, practices, and courses of business as are fraudulent, 
deceptive or manipulative.'' We are proposing rule 206(4)-6 as a 
means that we believe is reasonably necessary to prevent advisers 
from defrauding their clients in connection with the exercise of 
their proxy voting authority.
    \15\ Nothing in this proposal reduces or alters any fiduciary 
obligation applicable to any investment adviser (or person 
associated with any investment adviser).
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1. Advisers Subject to the Rule
    a. Registered Advisers. The rule would apply to advisers registered 
with the Commission that have voting authority with respect to client 
securities. Rule 206(4)-6, like our other anti-fraud rules under the 
Advisers Act, would not apply to smaller advisers that are registered 
with state securities authorities. Since the enactment of the National 
Securities Markets Improvement Act in 1996 (``NSMIA''), we have 
deferred to state securities authorities the regulation of these 
advisers, which do not have voting authority over substantial amounts 
of assets.\16\ The rule would also not apply to advisers that rely on 
an exemption from registration under section 203(b) of the Act,\17\ 
such as those advisers that have had fewer than 15 clients during the 
last twelve months, which we do not examine and to which most other 
provisions of the Act do not apply.
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    \16\ See section 203A of the Advisers Act, [15 U.S.C. 80b-3a], 
enacted as part of Title III of NSMIA. Pub. L. No. 104-290, 110 
Stat. 3416 (1996) (codified in scattered sections of the U.S. Code). 
NSMIA allocated regulatory authority for advisers with less than $25 
million of assets under management to state securities authorities. 
After NSMIA, our authority under section 206 continues to extend to 
state-registered advisers. However, when we adopted rules 
implementing NSMIA in 1997, we revised the anti-fraud rules under 
section 206 to apply only to SEC-registered investment advisers 
because the rules ``contain prophylactic provisions, and that after 
the effective date of [Title III of NSMIA] the application of these 
provisions to state-registered advisers is more appropriately a 
matter of state law.'' Rules Implementing Amendments to the 
Investment Advisers Act of 1940, Investment Advisers Act Release No. 
1633 (May 15, 1997) [62 FR 28112 (May 22, 1997)].
    \17\ 17 U.S.C. 80b-3(b).
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    [sbull] We request comment on the scope of proposed rule 206(4)-6. 
Should the rule apply to state-registered advisers? Should it apply to 
advisers that rely on an exemption from registration under section 
203(b) of the Act?
    b. Advisers with Voting Authority. Because we are concerned 
primarily with the proper exercise of voting authority of client 
proxies, only advisers that have voting authority would be subject to 
the rule.\18\ Advisers whose clients retain voting authority would not 
be required to adopt procedures or policies and would not be required 
to make any disclosures to clients under the rule. The rule would 
therefore not apply if an adviser provides a client with advice only as 
to how the client should vote a proxy. We are concerned that applying 
the rule to such advisers could result in numerous unintentional 
violations of the rule if, for example, a financial planner that never 
votes client proxies (and thus does not have policies and procedures 
and has not made the required disclosures) were to respond to a 
question from a client. The Advisers Act's general anti-fraud 
provisions would continue to apply, requiring the planner to disclose 
any material conflict that it may have to the client receiving the 
advice.
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    \18\ Some advisory contracts do not explicitly give the adviser 
voting authority. Instead, the adviser's authority to vote proxies 
is implied in the overall delegation of authority provided in the 
advisory contract, power of attorney, trust instrument or other 
document. Advisers entering into such contracts would be subject to 
the rule. Cf. DOL Interp. Bulletin, supra note (if the investment 
management agreement does not expressly preclude the investment 
manager from voting proxies, the investment manager has the 
exclusive responsibility for voting).
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    [sbull] Comment is requested regarding whether we should require 
all registered advisers to have policies and procedures.
    [sbull] Are there circumstances where an adviser with authority to 
vote client proxies should be exempt from the rule's requirements?
    [sbull] In some cases, clients retain some authority over the proxy 
vote, e.g., the client retains voting authority with respect to certain 
issues or the contract provides that the adviser should consult with 
the client on voting matters. How should the rule apply in these 
circumstances?
2. Written Policies and Procedures
    Rule 206(4)-6 would require investment advisers subject to the rule 
to adopt and implement written policies and procedures that are 
reasonably designed to ensure that the adviser votes proxies in the 
best interest of clients.\19\ Although advisers' proxy voting policies 
typically include a number of common elements,\20\ we are not proposing 
to specify the procedures or policies that advisers must adopt. 
Investment advisers registered with us have such different types of 
conflicts and organizational structures that we believe a ``one-size-
fits-all'' approach would not work.\21\
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    \19\ Proposed rule 206(4)-6(a). Nothing in the proposed rule 
would prevent an adviser from having different policies and 
procedures for different clients. Thus, the board of directors of an 
investment company could adopt and require an investment adviser to 
use different policies and procedures than the adviser uses with 
respect to its other clients.
    \20\ These common elements frequently deal with policies on 
particular types of matters that may be presented to shareholders, 
such as changes in corporate governance, changes in corporate 
structures, adoption or amendments to compensation plans (including 
stock options) and matters involving social issues or corporate 
responsibility. See supra note 2, Disclosure of Proxy Voting 
Policies and Proxy Voting Records By Registered Management 
Investment Companies, at Section II.A.
    \21\ Advisers registered with the Commission have assets under 
management that range from $580,000,000,000 to $7,020. While 4,923 
are organized as corporations (of which 3,265, or 66%, have 
financial industry affiliations), 367 are organized as sole 
proprietorships (of which 118, or 32%, have financial industry 
affiliations). While 94 of our advisers have more than 1,000 
employees, 5204 have 10 or fewer. Information obtained from SEC--
registered investment adviser Form ADV filings as of September 9, 
2002.
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    The rule would, however, contain three requirements. First, the 
proxy voting policies and procedures must be written.\22\ Second, they 
must describe

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how the adviser addresses material conflicts between its interests and 
those of its clients with respect to proxy voting. Finally, the 
policies and procedures must address how the adviser resolves those 
conflicts in the best interest of clients. The rule thus incorporates 
the standard that we believe applies to advisers as fiduciaries under 
the Advisers Act.\23\ We have included the standard in the proposed 
rule to clarify the obligation of advisers and to require that the best 
interest of clients be the focus of the policies and procedures.\24\
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    \22\ ``Written'' policies and procedures would, of course, 
include documents in electronic format. See Use of Electronic Media 
by Broker-Dealers, Transfer Agents, and Investment Advisers for 
Delivery Of Information, Investment Advisers Act Release No. 1562 
(May 9, 1996) [61 FR 24643 (May 15, 1996)].
    \23\ See discussion above in Section I of this release.
    \24\ The rule would not preclude an adviser from seeking 
assistance in collecting and voting proxies from, for example, a 
proxy voting service. Nor would the rule prevent an adviser from 
delegating authority to, for example, a committee. The adviser's 
delegation would not alter in any way the fiduciary responsibilities 
of the adviser.
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    In addition, we believe effective proxy voting policies and 
procedures of an adviser should identify personnel responsible for 
monitoring corporate actions, describe the basis on which decisions are 
made to vote proxies, and identify personnel (or groups) involved in 
making voting decisions and those responsible for ensuring that proxies 
are submitted in a timely manner. The extent to which the adviser 
relies on the advice of third parties or delegates to committees should 
also ordinarily be covered by the policies. Of course, the scope of the 
policies and procedures will turn on the nature of the adviser's 
advisory business, the types of securities portfolios it manages, and 
the extent to which clients, such as registered investment companies, 
have adopted their own procedures.\25\
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    \25\ Procedures that merely declare that all proxies will be 
voted in the best interests of clients would not be sufficient to 
meet the requirement of the proposed rule that the investment 
adviser adopt ``policies and procedures'' designed to assure that 
proxies are voted in the best interests of clients.
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    Many advisers may also be subject to fiduciary standards under 
ERISA and state common law.\26\ We believe that the ``best interest'' 
standard in the proposed rule is not inconsistent with those laws in 
any material respect.
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    \26\ Under ERISA, a person becomes a fiduciary to a plan by 
rendering it investment advice for a fee or other compensation. 
Section 3(21)(A)(ii) of ERISA [29 U.S.C. 1002(21)(a)(ii)]. An ERISA 
fiduciary must discharge its duties solely in the interest of the 
plan participants and for the exclusive purpose of providing 
benefits to plan participants with the care, prudence, and diligence 
that a prudent person would use. Section 404(a)(1) of ERISA [29 
U.S.C. 1104(a)(1)].
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    [sbull] Is the standard we have set forth in the rule clear?
    [sbull] Are there conflicts with other laws that we should address?
    [sbull] Should we include in the text of the rule additional 
required policies and procedures?
    [sbull] Alternatively, should we include in our adopting release 
additional policies and procedures that we believe are ``best 
practices'' for advisers to adopt? Commenters favoring additional 
policies and procedures should give specific recommendations.
3. Disclosure of How Clients Can Obtain Information on Votes
    Rule 206(4)-6 would also require an adviser subject to the rule to 
disclose to clients how they can obtain information from the adviser on 
how the adviser voted their proxies.\27\ We propose this provision for 
similar reasons to those we set forth in our companion release that 
would require investment companies to disclose how they have voted 
their proxies.\28\ We believe that ``sunshine'' on these votes will 
lead advisers to pay greater attention to their fiduciary obligations. 
Fully informed clients will serve as a check on their advisers' 
exercise of voting authority: clients who disapprove of how advisers 
vote their proxies may decide to reclaim the responsibility to vote 
proxies, provide the adviser with instructions on how to vote their 
proxies, or seek a different adviser whose voting policies they 
approve.
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    \27\ Proposed rule 206(4)-6(b). The requirement to disclose how 
a client can obtain information from the adviser on how it voted 
client securities could be satisfied by disclosure in the adviser's 
brochure. See supra note 11, Electronic Filing by Investment 
Advisers; Proposed Amendments to Form ADV (proposal to require 
advisers that have or will accept authority to vote client proxies 
to include in their brochures a description of their voting policies 
and procedures, including what means a client can pursue to find out 
how the adviser voted the client's proxies in particular 
solicitations).
    \28\ See supra note 2, Disclosure of Proxy Voting Policies and 
Proxy Voting Records By Registered Management Investment Companies.
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    Our proposal--which would require disclosure of how a client can 
obtain information--would not prescribe a right to that information. We 
assume that clients have a right to information about how their own 
proxies have been voted.\29\ And, unlike our investment company 
proposals, the proposed rule would not prescribe the nature, format, or 
scope of the information that must be disclosed. Many clients may not 
be interested in how the adviser votes. Those who are interested would 
typically only be entitled to know how the adviser has voted his or her 
proxies (and not those of other clients), and may need (or want) 
information only about one or a few critical votes. Requiring an 
adviser to prepare a list of votes for each client (most of whom may 
never request the information), specifying the time periods the 
information must cover (which time periods may not be responsive to a 
particular request), and the content of the information provided in the 
lists seems to us unnecessarily burdensome. Therefore, we would leave 
those decisions to clients and their advisers, which we would expect to 
be responsive to client requests.
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    \29\ The advisory contract could, however, limit a client's 
right to information about how the adviser has voted her proxy. See 
Restatement (Second) of Agency Sec.  381 (``[u]nless otherwise 
agreed, an agent is subject to a duty to use reasonable efforts to 
give his principal information which is relevant to affairs 
entrusted him * * *''). We believe that a contract that denied 
information to the client about how the adviser has voted proxies 
would be highly unusual and, unless initiated by the client, very 
troublesome in light of an adviser's fiduciary obligations.
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    [sbull] We request comment on our assumption that clients have the 
right to information about how their shares have been voted. Have 
advisers denied this information to clients? Should we include in the 
rule a right to this information? If so, what should be the scope of 
the right? For how many years should the adviser be required to retain 
information about votes and produce it upon request for a client?
    [sbull] Should the rule prescribe the content and format of 
required disclosures, as would the investment company rules we are 
proposing? If so, should the content and format of the required 
disclosure be different in any way from the proposed investment company 
rules?
4. Describe Policies and Procedures to Clients
    Finally, the proposed rule would require advisers subject to the 
rule to describe their proxy voting policies and procedures to clients 
and, upon request, furnish a copy of the policies and procedures to 
clients.\30\ This disclosure would help clients understand how the 
adviser votes proxies and permit clients to select advisers whose 
procedures and policies meet their expectations.\31\

[[Page 60845]]

Disclosure should also serve to encourage more effective policies and 
procedures.\32\
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    \30\ Proposed rule 206(4)-6(c). The requirement to describe the 
adviser's policies and procedures could be satisfied by disclosure 
in the adviser's brochure. See supra note , discussing Electronic 
Filing by Investment Advisers; Proposed Amendments to Form ADV (SEC 
proposal to require advisers to include this information in their 
brochure).
    \31\ In 1971, we recommended adoption of a similar requirement 
because we believed that ``[T]his type of public disclosure would 
focus the obligation of institutions to act in the interests of 
their beneficiaries and lead to their setting up procedures for 
systematic attention to questions of stockholder voting * * * the 
beneficiary should be able to choose the institutional manager whose 
policies on investment management appear to him most appropriate. 
The only way in which this can be done is to give beneficiaries full 
information about the policies followed.'' Letter from SEC 
Commissioner Richard B. Smith to Congress, transmitting the 
Institutional Investor Study Report (March 10, 1971), reprinted in, 
H.R. Doc No. 92-64, Part 1 (1971).
    \32\ The provisions of section 206 of the Act would be 
applicable to an investment adviser that disclosed its policies and 
procedures but then materially deviated from them.
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B. Amendments to Rule 204-2

    We are also proposing to amend rule 204-2 under the Advisers Act to 
require advisers subject to rule 206(4)6 to keep relevant records.\33\ 
These records would permit our examiners to ascertain compliance with 
the rule. They would also be necessary for an adviser to comply with 
the proposed requirement to disclose how the adviser has voted proxies 
for clients.
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    \33\ Those investment advisers subject to ERISA must already 
maintain ``adequate and accurate'' records as to the voting of ERISA 
plan proxies to permit monitoring by the plan trustee or other named 
fiduciary. See DOL Interp. Bulletin, supra note 12.
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    Under the proposed rule amendments, each adviser subject to rule 
206(4)-6 would be required to keep its proxy voting policies and 
procedures, records of proxy statements received, records of votes 
cast, records of all communications received and internal documents 
created that were material to the voting decision, and a record of each 
client request for proxy voting records and the adviser's response.\34\ 
We are proposing to require advisers to maintain proxy voting books and 
records in an easily accessible place for five years, the first two 
years in an appropriate office of the investment adviser.\35\
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    \34\ Proposed rule 204-2(c)(2).
    \35\ Proposed rule 204-2(e)(1). These are the same retention 
requirements that apply to most books and records under current rule 
204-2.
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III. General Request for Comment

    The Commission requests comment on the rule and amendments proposed 
in this release, suggestions for other additions to the rule and 
amendments, and comment on other matters that might have an effect on 
the proposals contained in this release. For purposes of the Small 
Business Regulatory Enforcement Fairness Act of 1996, the Commission 
also requests information regarding the potential impact of the 
proposed rule and amendments on the economy on an annual basis. 
Commenters should provide empirical data to support their views.

IV. Paperwork Reduction Act

    The proposed rule and amendments contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995.\36\ One of the collections of information is 
new. The Commission has submitted this new collection to the Office of 
Management and Budget (``OMB'') for review in accordance with 44 U.S.C. 
3507(d) and 5 CFR 1320.11. The title of this new collection is ``Rule 
206(4)-6;'' OMB has not yet assigned it a control number. The other 
collection of information takes the form of amendments to a currently-
approved collection titled ``Rule 204-2,'' under OMB control number 
3235-0278. The Commission has also submitted the amendments to this 
collection to the OMB for review in accordance with 44 U.S.C. 3507(d) 
and 5 CFR 1320.11. An agency may not conduct or sponsor, and a person 
is not required to respond to, a collection of information unless it 
displays a currently valid control number.
---------------------------------------------------------------------------

    \36\ 44 U.S.C. 3501 to 3520.
---------------------------------------------------------------------------

    The collection of information under rule 206(4)-6 is necessary to 
assure that investment advisers that vote proxies for their clients 
vote those proxies in their clients' best interest and provide their 
clients information about how their proxies were voted. This collection 
of information is mandatory. The respondents are investment advisers 
registered with us that vote proxies with respect to clients' 
securities. Clients of these investment advisers use the information 
collected to assess investment advisers' proxy voting policies and 
procedures and to monitor the adviser's performance of its proxy voting 
activities. Responses to the disclosure requirements are not kept 
confidential.
    The collection of information under rule 204-2 is necessary for the 
Commission staff to use in its examination and oversight program. This 
collection of information is mandatory. The respondents are investment 
advisers registered with us that vote proxies with respect to clients' 
securities. Responses provided to the Commission in the context of its 
examination and oversight program are generally kept confidential.\37\ 
The records that an adviser must keep in accordance with rule 204-2 
must generally be retained for not less than five years.\38\
---------------------------------------------------------------------------

    \37\ See section 210(b) of the Advisers Act [15 U.S.C. 80b-
10(b)].
    \38\ See rule 204-2(e) [17 CFR 275.204-2(e)].
---------------------------------------------------------------------------

A. Rule 206(4)-6

    According to our records, 6,203 of the 7,687 total advisers 
registered with the Commission manage client assets on a discretionary 
basis.\39\ For purposes of estimating the paperwork burden for 
investment advisers under proposed rule 206(4)-6, we will infer that 
these advisers vote proxies on behalf of one or more clients in 
connection with providing discretionary asset management services.\40\ 
We further estimate that each of these advisers would be required to 
spend on average 10 hours annually documenting its proxy voting 
procedures under the requirements of the proposed rule, for a total 
burden of 62,030 hours.\41\ In preparing this estimate, we have taken 
into account the fact that many advisers subject to ERISA because they 
manage plan assets already have proxy voting procedures in place which 
can serve as the basis of the adviser's procedures under the proposed 
rule.
---------------------------------------------------------------------------

    \39\ Based on our records of information submitted to us by 
investment advisers in Part 1 of Form ADV, 6,203 SEC-registered 
investment advisers report that they provide continuous and regular 
supervisory or management services for client securities portfolios 
on a discretionary basis.
    \40\ This estimate potentially overstates the number of advisers 
that would be subject to the rule. Part 1 of ADV does not require 
investment advisers to describe whether they vote proxies on behalf 
of clients. Nor does Part 1 require advisers to describe whether 
securities managed by the adviser are voting securities as opposed 
to, for example, government or other debt obligations for which 
proxy voting issues never arise.
    \41\ 6,203 x 10 = 62,030.
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    The proposed rule also would require these advisers to describe 
their proxy voting policies and procedures to clients. The attendant 
paperwork burden is already incorporated in a collection of information 
titled ``Form ADV,'' which is currently approved by OMB under control 
number 3235-0049.\42\ In addition, the proposed rule would require 
these investment advisers to provide copies of their proxy voting 
policies and procedures to clients upon request. While we estimate that 
SEC-registered advisers have, on average, 670

[[Page 60846]]

clients each,\43\ we estimate that, on average, at least 90 percent of 
each of these adviser's clients would find the adviser's description of 
its policies sufficiently informative, and ten percent at most, or 67 
clients of each adviser on average, would request copies of the 
underlying policies and procedures.\44\ We estimate that it would take 
these advisers 0.1 hours per client to deliver copies of the policies 
and procedures, for a total burden of 41,560 hours.\45\
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    \42\ In April of 2000, we proposed amendments to Form ADV, Part 
2 that would require investment advisers that vote client proxies to 
describe their proxy voting policies and procedures in their 
brochure. Electronic Filing by Investment Advisers; Proposed 
Amendments to Form ADV, Investment Advisers Act Release No. 1862 
(April 5, 2000) [65 FR 20524 (April 17, 2000)]. An adviser could 
satisfy the disclosure requirements under proposed rule 206(4)-6(b) 
and (c) by describing its policies and procedures in its brochure. 
See supra notes 27 and 30. In connection with our April 2000 
proposal, when we obtained OMB approval for our amendments to the 
Form ADV collection that would result from the proposed changes to 
Part 2, we included the paperwork burden of describing any proxy 
voting policies and procedures in a firm's brochure.
    \43\ See Custody of Funds or Securities of Clients by Investment 
Advisers, Investment Advisers Act Release No. 2044 (July 18, 2002) 
[67 FR 48579 (July 25, 2002)].
    \44\ 670 x 10% = 67.
    \45\ 0.1 x 67 x 6,203 = 41,560. In connection with submitting 
this collection of information to OMB, the Commission has also 
prepared an estimate of the aggregate annual cost to affected firms 
of this annual aggregate hour burden. We anticipate that investment 
advisers would likely use compliance professionals to document their 
firms' proxy voting policies and procedures. We estimate the hourly 
wage for compliance professionals to be $60, including benefits. We 
anticipate that investment advisers would likely use clerical staff 
to deliver copies of proxy voting policies in response to clients' 
requests. We estimate the hourly wage for clerical staff to be $10, 
including benefits. Accordingly, we estimate the annual aggregate 
cost of collection to be $4,137,400 ((62,030 hours x $60 per hour) + 
(41,560 hours x $10 per hour) = $4,137,400).
---------------------------------------------------------------------------

    Accordingly, we estimate that proposed rule 206(4)-6 would increase 
the annual aggregate burden of collection for SEC-registered investment 
advisers by a total of 103,590 hours.\46\
---------------------------------------------------------------------------

    \46\ 62,030 + 41,560 = 103,590.
---------------------------------------------------------------------------

B. Rule 204-2

    The currently-approved annual aggregate burden of collection under 
rule 204-2 is 1,582,293 hours. This approved annual aggregate burden 
was based on estimates that 8,100 advisers were subject to the rule, 
and each of these advisers spend an average of 195.34 hours each 
preparing and preserving records in accordance with the rule. Updating 
those prior calculations based on current information from SEC-
registered investment advisers, however, we would now estimate that 
7,687 are subject to the rule. We would continue to estimate that each 
of these advisers spend an average of 195.34 hours each preparing and 
preserving records in accordance with the rule. These current data 
would decrease the annual aggregate burden under the rule to 
1,501,578.5 hours,\47\ which is a reduction of 80,714.5 hours.\48\
---------------------------------------------------------------------------

    \47\ 7,687 x 195.34 = 1,501,578.5.
    \48\ 1,582,293 `` 1,501,578.5 = 80,714.5.
---------------------------------------------------------------------------

    The proposed amendments to rule 204-2 would require registered 
investment advisers that vote client proxies to maintain specified 
records with respect to those clients. These advisers must maintain 
copies of their policies and procedures that would be required under 
proposed rule 206(4)-6, as well as copies or records of each proxy 
statement received with respect to the securities of clients for whom 
the adviser exercises voting authorities. These advisers must also 
maintain a record of each vote cast, as well as a record of all 
communications received and all internal documents created that were 
material to the adviser's decision on the vote. In addition, the 
adviser would be required to maintain a record of each client request 
for proxy voting information and the adviser's response. The adviser 
would be required to maintain these records in the same manner, and for 
the same period of time, as other books and records are currently 
required to be maintained under rule 204-2(e)(1).
    We estimate that these proposed amendments would increase the 
average annual collection burden of an adviser subject to the 
amendments by 20 hours, to 215.34 hours.\49\ As discussed above in 
connection with proposed rule 206(4)-6, we estimate that 6,203 advisers 
exercise voting authority on behalf clients and will thus be subject to 
this additional burden, for an annual aggregate burden increase of 
124,060.\50\ The average annual burden for SEC-registered investment 
advisers under rule 204-2 would accordingly increase from 195.34 hours 
to 211.48 hours.\51\
---------------------------------------------------------------------------

    \49\ 195.34 + 20 = 215.34.
    \50\ 20 x 6,203 = 124,060. In connection with submitting this 
collection of information to OMB, the Commission has also prepared 
an estimate of the aggregate annual cost to affected firms of this 
annual aggregate hour burden. We anticipate that investment advisers 
would likely use compliance clerical staff to maintain the records 
required under the proposed amendments. We estimate the hourly wage 
for compliance clerical staff to be $13.20, including benefits. 
Accordingly, we estimate the annual aggregate cost of collection to 
be $1,637,592 (124,060 hours x $13.20 per hour = $1,637,592).
    \51\ (1,501,578.5 current hours +124,060 additional hours = 
1,625,638.5 aggregate burden hours) / 7,687 SEC-registered 
investment advisers = 211.48.
---------------------------------------------------------------------------

C. Request for Comment

    We request comment whether these estimates are reasonable. Pursuant 
to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to:
    [sbull] evaluate whether the proposed collections of information 
are necessary for the proper performance of the functions of the 
Commission, including whether the information will have practical 
utility;
    [sbull] evaluate the accuracy of the Commission's estimate of the 
burden of the proposed collections of information;
    [sbull] determine whether there are ways to enhance the quality, 
utility, and clarity of the information to be collected; and
    [sbull] determine whether there are ways to minimize the burden of 
the collections of information on those who are to respond, including 
through the use of automated collection techniques or other forms of 
information technology.
    Persons wishing to submit comments on the collection of information 
requirements should direct them to the Office of Management and Budget, 
Attention: Desk Officer for the Securities and Exchange Commission, 
Office of Information and Regulatory Affairs, Room 3208, Washington, DC 
20503, and also should send a copy to Jonathan G. Katz, Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609 with reference to File No. S7-38-02. OMB is required to 
make a decision concerning the collections of information between 30 
and 60 days after publication, so a comment to OMB is best assured of 
having its full effect if OMB receives the comment within 30 days after 
publication of this release. Requests for materials submitted to OMB by 
the Commission with regard to these collections of information should 
be in writing, refer to File No. S7-38-02, and be submitted to the 
Securities and Exchange Commission, Records Management, Office of 
Filings and Information Services, 450 Fifth Street, NW, Washington, DC 
20549.

V. Cost-Benefit Analysis

    We are sensitive to the costs and benefits resulting from our 
rules. While investment advisers exercise enormous proxy voting power 
as part of their discretionary management of their clients' securities, 
the federal securities laws do not specifically address how advisers 
must exercise this voting authority. Proposed rule 206(4)-6 is designed 
to ensure that advisers vote client securities in the client's best 
interest and to provide clients information on how their securities are 
voted.
    Investment advisers today have discretionary investment authority 
with respect to almost $19trillion of assets, including large holdings 
in equity securities. In most cases, these advisers are given authority 
to vote proxies on equity securities on behalf of their clients. Under 
the Advisers Act, investment advisers are fiduciaries that must act in 
their clients' best interest with respect to functions undertaken on 
behalf of their clients, including these proxy voting activities. An 
adviser's fiduciary duty includes the duty of care and the duty of 
loyalty to clients. For an

[[Page 60847]]

adviser that has been given authority to vote proxies, the duty of care 
includes the duty to monitor corporate events and vote proxies; the 
duty of loyalty requires the adviser to vote proxies in a manner 
consistent with the best interest of its client and precludes the 
adviser from subrogating the client's interest to its own.
    The Commission is concerned with conflicts of interest between 
advisers and their clients. Advisers (or their affiliates) frequently 
manage assets, administer employee benefit plans, or provide brokerage, 
underwriting, or insurance services to companies whose management is 
soliciting proxies. These business interests may expose advisers to 
pressure to vote in favor of management. Other business relationships 
may expose advisers to pressure to vote in favor of the proponent of a 
proxy question, such as when an adviser manages money for an employee 
group. In other instances, advisers may be exposed to pressure as a 
result of personal relationships with participants in proxy contests, 
corporate directors, or candidates for directorships.
    The importance of proxy voting by investment advisers--both to 
their clients and to our system of corporate governance--as well as the 
many conflicts faced by advisers suggest a need for the Commission to 
address proxy voting by investment advisers under the Advisers Act. 
While many advisers have adopted policies and procedures designed to 
ensure that client proxies are properly voted, material conflicts are 
avoided, and fiduciary obligations are fulfilled, others do not have 
these procedures in place.
    Therefore, the Commission is proposing a new rule under the 
Advisers Act designed to prevent material conflicts of interest from 
affecting the manner in which advisers vote client proxies. We have 
identified certain costs and benefits of the proposed rule and rule 
amendments. We request comment on the costs and benefits of the 
proposed rule amendments, and encourage commenters to identify, 
discuss, analyze, and supply relevant data regarding these or any 
additional costs or benefits.

A. Background

    Proposed rule 206(4)-6 is designed to ensure that advisers vote 
client securities in the client's best interest and to provide clients 
information on how their securities are voted. The proposed rule would 
require an SEC-registered investment adviser that votes client proxies 
to adopt written policies and procedures reasonably designed to ensure 
the adviser votes proxies in the best interest of the client, including 
procedures to address any material conflict that may arise between the 
interest of the adviser and the client. The proposed rule would also 
require the adviser to describe these policies and procedures to 
clients, and to provide copies of the policies and procedures to 
clients upon their request. In addition, the proposed rule would 
require these advisers to disclose to clients how they may obtain 
information from the adviser about how the adviser voted their proxies.
    We are not proposing to specify the procedures or policies that 
advisers must adopt under the proposed rule. Investment advisers 
registered with us have such different types of conflicts and 
organizational structures that we believe a ``one-size-fits-all'' 
approach would not work. The rule would, however, require written 
procedures that describe how the adviser addresses material conflicts 
between its interests and those of its clients with respect to proxy 
voting, and how the adviser resolves those conflicts in the best 
interest of clients. The rule thus incorporates the standard that we 
believe applies to advisers as fiduciaries under the Advisers Act.
    We are also proposing amendments to rule 204-2 under the Advisers 
Act that would require registered investment advisers that vote client 
proxies to maintain specified records with respect to those clients. 
These advisers would be required to maintain copies of the policies and 
procedures to be required under proposed rule 206(4)-6, as well as 
copies or records of each proxy statement received with respect to the 
securities of clients for whom the adviser votes proxies. These 
advisers must also maintain a record of each vote cast, as well as a 
record of all communications received and all internal documents 
created that were material to the adviser's decision on the vote. In 
addition, the adviser would be required to maintain a record of each 
client request for proxy voting information and the adviser's response. 
These records would permit our examiners to ascertain compliance with 
the rule. They would also be necessary for an adviser to comply with 
the proposed requirement to disclose how the adviser has voted proxies 
for clients.
    Based on advisers' filings with us, we estimate that the majority 
of investment advisers registered with us vote proxies on behalf of 
their clients. SEC-registered advisers are not currently required to 
submit information to us describing their proxy voting practices. 
However, according to our records as of September 9, 2002, 6,203 of the 
7,687 total advisers registered with us manage client assets on a 
discretionary basis.\52\ Since in most instances advisers with 
discretionary investment authority are given authority to vote proxies 
relating to equity securities under management, it is likely that 
significant numbers of these 6,203 advisers vote proxies on behalf of 
one or more clients in connection with providing discretionary asset 
management services.\53\
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    \52\ This estimate is based on information submitted by SEC-
registered advisers in Form ADV, Part 1 [17 CFR 279.1]. 6,203 SEC-
registered investment advisers reported that they provide continuous 
and regular supervisory or management services for client securities 
portfolios on a discretionary basis.
    \53\ Because Part 1 of Form ADV does not require advisers to 
describe the types of securities for which they hold discretionary 
investment authority, some of these advisers may only manage 
securities for which proxy voting issues never arise, such as 
government or other debt obligations.
---------------------------------------------------------------------------

B. Benefits

    Advisory clients will receive benefits from the proposed 
amendments. The proxy voting procedures contemplated under the rule 
will ensure that advisers have a system in place designed to identify 
and address any material conflicts of interest with respect to each 
proxy voted by the adviser on a client's behalf, and to vote the proxy 
in the client's best interest. Many advisers may be exposed to varying 
types of conflicts from differing sources, and it benefits clients when 
advisers take special measures to ensure that all conflicts are 
properly addressed.
    The proposed rule would also require these advisers to describe 
their proxy voting policies and procedures to clients, and require the 
adviser to furnish copies of the policies and procedures to clients 
upon request. Clients will benefit from this disclosure by gaining an 
understanding of how the adviser votes proxies. Clients will be in a 
better position to determine whether their adviser's policies and 
procedures meet their expectations.
    In addition, the proposed rule requires advisers to disclose to 
their clients how they can obtain information on how the adviser voted 
their proxies. Fully informed clients will serve as a check on their 
advisers' exercise of voting authority: clients who disapprove of how 
advisers vote their proxies may decide to reclaim the responsibility to 
vote proxies, provide the adviser with instructions on how to vote 
their proxies, or seek a different adviser whose voting policies they 
approve.
    These potential benefits to clients are difficult to quantify. In 
addition, some

[[Page 60848]]

clients may already be receiving some of these benefits in certain 
instances; applicable law entitles clients to their adviser's fiduciary 
care and loyalty in connection with proxy voting, as well as 
information about how their proxies were voted, and some advisory firms 
have adopted policies and procedures addressing proxy voting. To the 
extent clients are receiving these benefits as a matter of practice, 
the potential benefit of having these practices institutionalized 
through a rule is also difficult to quantify.

C. Costs

    The proposed rule and rule amendments would impose some costs on 
advisers that vote client proxies. These advisers would incur costs in 
connection with establishing and operating the procedures contemplated 
by the proposed rule, and in connection with expanding their 
recordkeeping systems to include new material on proxy voting. These 
advisers would also incur costs in preparing descriptions of their 
policies and procedures for clients, as well as in responding to client 
requests for copies of the advisers' policies and procedures. Finally, 
these advisers would incur costs in responding to any client requests 
for information about how the adviser voted the client's proxies.
    The initial and ongoing compliance costs imposed by the proposed 
rule would vary significantly among advisers based on several factors 
that are as diverse as the differing types of advisory firms and 
clients affected by the proposal. For example, firms that invest their 
clients' assets in numerous equity issues must review more proxy votes 
than firms that invest their clients' assets in few equity issues.\54\ 
Firms with a wide diversity of business and individual advisory clients 
may be more likely to face conflicts than other firms, and firms that 
are part of financial organizations that provide other financial 
services may face more conflicts than stand-alone firms. Clients of a 
``social investing'' firm may be keenly interested in the firm's proxy 
voting practices, but the firm is likely to have already developed 
systems that would largely address the proposed requirements. Clients 
of other firms may be interested in how the adviser votes only rarely, 
with regard to high-profile proxy contests, and the firm's cost of 
responding to client inquiries is likely to be small.
---------------------------------------------------------------------------

    \54\ For example, the firm is a fixed income manager, which does 
not manage voting equity securities, or the firm does not manage 
significant client assets.
---------------------------------------------------------------------------

    In addition, we believe that many advisers that would be affected 
by the proposed rule have already developed proxy voting policies and 
procedures, and would incur fewer new costs as a result. Investment 
advisers subject to ERISA because they manage retirement plan assets 
vote client proxies in many instances, and through our investment 
adviser inspection program, we have determined that this group of 
advisers typically has proxy voting policies and procedures in place. 
These advisers could likely use some, or all, of these procedures to 
meet the obligations under the proposed rules. Moreover, many of these 
advisers are the larger firms that would likely incur the most costs 
associated with the proposed rules.
    In connection with estimating the annual aggregate burden of the 
proposed rule and amendments for purposes of the Paperwork Reduction 
Act, Commission staff has estimated that advisory firms affected by the 
rule will incur staff salary and benefit costs aggregating 
approximately $5,775,000 to prepare and maintain the documents and 
records required under the proposal.\55\ This is an aggregate estimate, 
and each firm's individual costs in this regard will vary depending on 
the nature of the firm's advisory business and clients, as discussed 
above. Moreover, many firms that are subject to ERISA because they 
manage retirement plan assets already have proxy voting policies and 
procedures in place, as discussed above, and are already incurring some 
portion of these costs.
---------------------------------------------------------------------------

    \55\ As discussed supra note 45, we anticipate that investment 
advisers would likely use compliance professionals to document their 
firms' proxy voting policies and procedures, for an aggregate annual 
average of 62,030 hours at an average wage and benefit cost of $60 
per hour, for an aggregate cost of $3,721,800. We anticipate that 
investment advisers would likely use clerical staff to deliver 
copies of proxy voting policies in response to clients' requests, 
for an aggregate annual average of 41,560 hours at an average wage 
and benefit cost of $10 per hour, for an aggregate cost of $415,600. 
As discussed supra note 50, we anticipate that investment advisers 
would likely use compliance clerical staff to maintain the records 
required under the proposed amendments, for an aggregate annual 
average of 124,060 hours at an average wage and benefit cost of 
$13.20 per hour, for an aggregate cost of $1,637,592. $3,721,800 + 
$415,600 + $1,637,592 = $5,774,992. For these estimates, we used 
wage and benefit rates published by the Securities Industry 
Association. See Securities Industry Association, Report on 
Management and Professional Earnings in the Securities Industry 2001 
(Oct. 2001); Report on Office Salaries in the Securities Industry 
(Oct. 2001).
---------------------------------------------------------------------------

D. Request for Comment

    [sbull] The Commission requests comment on the potential costs and 
benefits identified in this release, as well as any other costs or 
benefits that may result from the proposal.
    [sbull] We encourage commenters to identify, discuss, analyze, and 
supply relevant data regarding these or additional costs and benefits.

VI. Initial Regulatory Flexibility Analysis

    The Commission has prepared the following Initial Regulatory 
Flexibility Analysis (``IRFA'') regarding proposed rule 206(4)-6 and 
proposed amendments to rule 204-2 in accordance with section 3(a) of 
the Regulatory Flexibility Act.\56\
---------------------------------------------------------------------------

    \56\ 5 U.S.C. 603(a).
---------------------------------------------------------------------------

A. Reasons for Proposed Action

    While investment advisers exercise enormous proxy voting power as 
part of their discretionary management of their clients' securities, 
the federal securities laws do not specifically address how advisers 
must exercise this voting authority. Investment advisers today have 
discretionary investment authority with respect to almost $19 trillion 
of assets, including large holdings in equity securities. In most 
cases, these advisers are given authority to vote proxies on equity 
securities on behalf of their clients. Under the Advisers Act, 
investment advisers are fiduciaries that must act in their clients' 
best interest with respect to functions undertaken on behalf of their 
clients, including these proxy voting activities. An adviser's 
fiduciary duty includes the duty of care and the duty of loyalty to 
clients. For an adviser that has been given authority to vote proxies, 
the duty of care includes the duty to monitor corporate events and vote 
proxies; the duty of loyalty requires the adviser to vote proxies in a 
manner consistent with the best interest of its client and precludes 
the adviser from subrogating the client's interest to its own.
    The Commission is concerned with conflicts of interest between 
advisers and their clients. Advisers (or their affiliates) frequently 
manage assets, administer employee benefit plans, or provide brokerage, 
underwriting, or insurance services to companies whose management is 
soliciting proxies. These business interests may expose advisers to 
pressure to vote in favor of management. Other business relationships 
may expose advisers to pressure to vote in favor of the proponent of a 
proxy question, such as when an adviser manages money for an employee 
group. In other instances, advisers may be exposed to pressure as a 
result of personal relationships with participants in proxy contests, 
corporate

[[Page 60849]]

directors, or candidates for directorships.
    The importance of proxy voting by investment advisers--both to 
their clients and to our system of corporate governance--as well as the 
many conflicts faced by advisers suggest a need for the Commission to 
address proxy voting by investment advisers under the Advisers Act. 
While many advisers have adopted policies and procedures designed to 
ensure that client proxies are properly voted, material conflicts are 
avoided, and fiduciary obligations are fulfilled, others do not have 
these procedures in place. Therefore, the Commission is proposing a new 
rule under the Advisers Act designed to prevent material conflicts of 
interest from affecting the manner in which advisers vote client 
proxies.

B. Objectives and Legal Basis

    Proposed rule 206(4)-6 is designed to ensure that advisers vote 
client securities in the client's best interest and to provide clients 
information on how their securities are voted. The proposed rule would 
require an investment adviser that votes client proxies to adopt 
written policies and procedures reasonably designed to ensure the 
adviser votes proxies in the best interest of the client, including 
procedures to address any material conflict that may arise between the 
interest of the adviser and the client. The proposed rule would also 
require the adviser to disclose to clients information about those 
procedures and policies and how clients may obtain information on how 
the adviser has voted their proxies. The Commission is also proposing 
amendments to rule 204-2 to require advisers that vote client proxies 
to keep certain records regarding the proxy votes.
    The proposed rule and amendments will serve three main objectives. 
First, the written policies and procedures required under proposed rule 
206(4)-6 are designed to ensure that an adviser voting proxies on 
behalf of its client fulfills its fiduciary duties, including its duty 
to address any material conflict between the adviser's interests and 
those of its client. Second, the disclosures required under proposed 
rule 206(4)-6 are designed to provide clients with a greater 
understanding of their adviser's proxy voting practices, permit clients 
to determine whether their adviser's policies and procedures meet their 
expectations, and serve as a check on their advisers' exercise of 
voting authority if they disapprove of votes cast on their behalf. 
Third, the amendments to rule 204-2 will clarify the recordkeeping 
obligations an adviser has with respect to voting client securities and 
provide our examiners a means to assess compliance with proposed rule 
206(4)-6.
    The Commission is proposing rule 206(4)-6 pursuant to the authority 
set forth in sections 206(4) and 211(a) of the Advisers Act [15 U.S.C. 
80b-6(4) and 80b-11(a)] and amendments to rule 204-2 pursuant to the 
authority set forth in sections 204 and 206(4) of the Advisers Act [15 
U.S.C. 80b-4 and 80b-6(4)]. Section 206(4) gives us authority to issue 
rules designed to prevent fraudulent, deceptive, or manipulative acts 
or practices. Section 211 gives us authority to clarify, by rule, 
persons and matters within our jurisdiction and to prescribe different 
requirements for different classes of persons, as necessary or 
appropriate to the exercise of our authority under the Act. Section 204 
gives us authority, by rule, to require an investment adviser to make 
and keep records.

C. Small Entities Subject to Rule

    Under Commission rules, for the purposes of the Advisers Act and 
the Regulatory Flexibility Act, an investment adviser generally is a 
small entity if it: (i) Has assets under management having a total 
value of less than $25 million; (ii) did not have total assets of $5 
million or more on the last day of its most recent fiscal year; and 
(iii) does not control, is not controlled by, and is not under common 
control with another investment adviser that has assets under 
management of $25 million or more, or any person (other than a natural 
person) that had $5 million or more on the last day of its most recent 
fiscal year.\57\ The Commission estimates that as of September 9, 2002 
approximately 138 SEC-registered investment advisers that might 
potentially be affected by the rule were small entities.\58\
---------------------------------------------------------------------------

    \57\ 17 CFR 275.0-7(a).
    \58\ This estimate is based on the information submitted by SEC-
registered advisers in Part 1 of Form ADV. Advisers are not required 
to describe on Part 1 whether they vote proxies on behalf of their 
clients. These 138 small advisers report on their Part 1 that they 
provide continuous and regular supervisory or management services 
for client securities portfolios on a discretionary basis. For 
purposes of estimating the number of small advisers that might vote 
client proxies and thus be subject to the proposal, we will infer 
that these 138 advisers vote proxies on behalf of one or more 
clients in connection with providing discretionary asset management 
services. This estimate potentially overstates the number of small 
advisers that would actually be subject to the rule. For example, 
the assets under discretionary management at some of these firms may 
consist of government or other debt obligations for which proxy 
voting issues never arise.
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D. Reporting, Recordkeeping, and Other Compliance Requirements

    The proposed rule and rule amendments would impose no new reporting 
requirements. The proposed rule and rule amendments would create 
certain new compliance and recordkeeping requirements. The proposed 
rule imposes a new compliance requirement by making it unlawful for an 
SEC-registered investment adviser to vote proxies on behalf of clients 
unless the adviser has adopted written policies and procedures on proxy 
voting. The proposed rule amendments impose new recordkeeping 
requirements by requiring these advisers to maintain certain records 
regarding proxy voting.
    Small advisers would only expend efforts to meet these new 
compliance and recordkeeping requirements to the extent these advisers 
have authority to vote proxies on behalf of their clients. Advisers 
typically vote client proxies in connection with managing client assets 
on a discretionary basis, and small advisers engage in discretionary 
asset management on a limited scale. Therefore, it is likely that these 
advisers will make relatively few proxy votes on behalf of their 
clients, and will not have to dedicate significant resources to comply 
with the compliance and recordkeeping amendments in connection with 
those votes.

E. Duplicative, Overlapping, or Conflicting Federal Rules

    The Commission believes that there are no rules that duplicate or 
conflict with the proposed rule. Proposed rule 206(4)-6 overlaps with 
certain provisions of ERISA.\59\ Pursuant to the Department of Labor's 
interpretation of sections 402, 403, and 404 of ERISA, an investment 
manager that has delegated authority to manage plan assets has a 
fiduciary obligation to vote proxies that affect the value of plan 
investments unless the investment management contract expressly 
precludes the manager from voting proxies.\60\ The interpretation also 
states that the investment manager is required to maintain records as 
to proxy voting.\61\ The provisions of ERISA do not apply to all 
investment advisers registered with us, but do apply to those 
investment advisers that meet the ERISA definition of investment

[[Page 60850]]

manager.\62\ We do not believe our proposed rule and rule amendments 
conflict with the obligations that an investment adviser may have under 
ERISA.
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    \59\ 29 U.S.C. 1001, et. seq.
    \60\ Dept. of Labor, Interpretive Bulletin Relating to Written 
Statements of Investment Policy, Including Proxy Voting Guidelines, 
29 CFR 2509.94-2 (2001).
    \61\ Id.
    \62\ An investment manager under ERISA is any plan fiduciary, 
other than a trustee or named fiduciary, who has the power to manage 
plan assets, has acknowledged its fiduciary status, and is either an 
investment adviser (registered with the SEC or the states), bank, or 
insurance company. Section 3(38) of ERISA [29 U.S.C. 1002(38)].
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F. Significant Alternatives

    The Regulatory Flexibility Act directs the Commission to consider 
significant alternatives that would accomplish the stated objectives, 
while minimizing any adverse impact on small entities. In connection 
with the proposed rule, the Commission considered the following 
alternatives: (i) The establishment of differing compliance or 
reporting requirements or timetables that take into account the 
resources available to small entities; (ii) the clarification, 
consolidation, or simplification of compliance and reporting 
requirements under the rule for such small entities; (iii) the use of 
performance rather than design standards; and (iv) an exemption from 
coverage of the rule, or any part thereof, for such small entities.
    The Commission has drafted proposed rule 206(4)-6 to permit each 
firm subject to the rule to design and structure its own policies and 
procedures in light of the firm's operational structure and the 
particular types of conflicts encountered by the firm in connection 
with its unique business and clients. In the same way, the proposed 
amendments to rule 204-2 would permit each firm to develop its own 
system for capturing and retaining the requisite information. In 
connection with considering whether to establish differing compliance 
or recordkeeping requirements or timetables for small entities, as well 
as whether to use performance rather than design standards, the 
Commission believes at this time that the flexibility already built in 
to the proposal adequately addresses these alternatives.
    In considering whether to attempt to clarify, consolidate, or 
simplify the compliance and recordkeeping requirements under the rule 
for small entities, the Commission believes at this time that the 
proposal achieves the appropriate balance between simplicity and 
investor protection, and any further simplification would unacceptably 
compromise such protection. The minimum criteria specified for proxy 
voting procedures and client disclosures under proposed rule 206(4)-6 
are designed to ensure advisers vote proxies in the best interest of 
their clients and provide clients information about how their 
securities are voted. Elimination of some or all of these criteria 
would potentially impede achievement of that objective. Similarly, in 
establishing the categories of records to be retained under the 
proposed amendments to rule 204-2, the records described by the rule 
are all necessary if the Commission is to be able to evaluate advisers' 
compliance with proposed rule 206(4)-6 as part of the Commission's 
inspection program.
    Finally, the Commission believes that it would be inconsistent with 
the purposes of the Advisers Act to exempt small entities from the 
proposed rule and rule amendments. The proposed policies and procedures 
are designed to ensure clients are afforded the full protections 
attendant to an adviser's fiduciary duties as recognized by the 
Adviser's Act when an adviser is voting their proxies. The proposed 
disclosure requirements would provide advisory clients with information 
about its adviser's proxy voting policies and procedures and instruct 
clients how to obtain information on how the adviser voted their 
proxies. Different disclosure requirements would leave some advisory 
clients without the requisite information necessary to assess their 
adviser's proxy voting practices. Since the protections of the Advisers 
Act are intended to apply equally to clients of both large and small 
advisory firms, it would be inconsistent with the purposes of the Act 
to specify different requirements for small entities.

G. Solicitation of Comment

    We encourage written comments on matters discussed in the IRFA. In 
particular the Commission seeks comment on:
    [sbull] The number of small entities that would be affected by the 
proposed rule and rule amendments; and
    [sbull] Whether the effects of the proposed rule and rule 
amendments on small entities would be economically significant.
    Commenters are asked to describe the nature of any effect and 
provide empirical data supporting the extent of the effect.

VII. Statutory Authority

    We are proposing new rule 206(4)-6 pursuant to our authority set 
forth in sections 206(4) and 211(a) of the Advisers Act [15 U.S.C. 80b-
6(4) and 80b-11(a)].
    We are proposing amendments to rule 204-2 pursuant to our authority 
set forth in sections 204 and 206(4) of the Advisers Act [15 U.S.C. 
80b-4 and 80b-6(4)].

List of Subjects in 17 CFR Part 275

    Reporting and recordkeeping requirements, Securities.

Text of Proposed Rule

    For the reasons set out in the preamble, title 17, chapter II of 
the Code of Federal Regulations is proposed to be amended as follows:

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

    1. The authority citation for part 275 continues to read in part as 
follows:

    Authority: 15 U.S.C. 80b-2(a)(11)(F), 80b-2(a)(17), 80b-3, 80b-
4, 80b-6(4), 80b-6a, 80b-11, unless otherwise noted.
* * * * *
    2. Section 275.204-2 is amended by:
    a. Redesignating paragraph (c) introductory text, paragraphs (c)(1) 
and (c)(2) as paragraph (c)(1) introductory text, paragraphs (c)(1)(i) 
and (c)(1)(ii) respectively;
    b. Adding new paragraph (c)(2); and
    c. Revising paragraph (e)(1).
    The additions and revisions read as follows:


Sec.  275.204-2  Books and records to be maintained by investment 
advisers.

* * * * *
    (c) * * *
    (2) Every investment adviser subject to paragraph (a) of this 
section that exercises voting authority with respect to client 
securities shall, with respect to those clients, make and retain the 
following:
    (i) All policies and procedures required by Sec.  275.206(4)-6.
    (ii) A copy of each proxy statement that you receive regarding 
client securities.
    (iii) A record of each vote cast by the investment adviser on 
behalf of a client.
    (iv) A record of all oral and a copy of all written communications 
received and memoranda or similar documents created by the investment 
adviser that were material to making a decision on voting client 
securities.
    (v) A record of each client request for proxy voting information 
and the investment adviser's response, including the date of the 
request, the name of the client, and date of the response.
* * * * *
    (e)(1) All books and records required to be made under the 
provisions of paragraphs (a) to (c)(1)(i), inclusive, and (c)(2) of 
this section (except for books and records required to be made under 
the provisions of paragraphs (a)(11) and (a)(16) of this section), 
shall be maintained and preserved in an easily

[[Page 60851]]

accessible place for a period of not less than five years from the end 
of the fiscal year during which the last entry was made on such record, 
the first two years in an appropriate office of the investment adviser.
* * * * *
    3. Section 275.206(4)-6 is added to read as follows:


Sec.  275.206(4)-6  Proxy voting.

    If you are an investment adviser registered or required to be 
registered under section 203 of the Act (15 U.S.C. 80b-3), it is a 
fraudulent, deceptive, or manipulative act, practice or course of 
business within the meaning of section 206(4) of the Act (15 U.S.C. 
80b-6(4)), for you to exercise voting authority with respect to client 
securities, unless you:
    (a) Adopt and implement written policies and procedures that are 
reasonably designed to ensure that you vote client securities in the 
best interest of clients, which procedures must include how you address 
material conflicts that may arise between your interests and those of 
your clients;
    (b) Disclose to clients how they may obtain information from you 
about how you voted with respect to their securities; and
    (c) Describe to clients your proxy voting policies and procedures 
and, upon request, furnish a copy of the policies and procedures to the 
requesting client.

    By the Commission.

    Dated: September 20, 2002.
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 02-24410 Filed 9-25-02; 8:45 am]
BILLING CODE 8010-01-P