New mutual fund disclosure rules on proxy voting have received only scant attention from the funds industry, but they are promising to reshape the future of shareholder activism in Canada.

The new rules, part of a package of continuous disclosure reforms proposed by the Canadian Securities Administrators in May, include new requirements for funds to provide information on their proxy policies and voting records to unitholders on request. The new rules are set to take effect Dec. 31.

Mutual funds control vast amounts of stock on behalf of their investors. In the U.S., the Securities and Exchange Commission estimates that mutual funds control 19% of all publicly traded corporate equity, giving the fund industry huge influence on corporate management.

Yet, curiously, mutual funds have been reluctant to exercise the power they hold. Fund companies typically vote with corporate management on shareholder proposals.
The proposals often involve controversial issues of fundamental importance. Look at the fight around executive compensation and dual-class share structures at Magna International Inc. this past spring, or the ongoing debate among shareholders at Petro-Canada and Imperial Oil Ltd. on the issue of climate change, or the controversy around sweatshop contracting at Wal-Mart Stores Inc.

The new rules – when approved by the CSA – will lift the veil on proxy voting by requiring funds to keep records on their votes, and to establish policies and procedures to govern how they vote. Moreover, the rules provide for transparency in the process by ensuring that interested unitholders can obtain a copy of the policies and voting records.

The Investment Funds Institute of Canada maintains that few mutual fund investors are interested in how their funds vote on shareholder proposals. That may be true, but the CSA wisely asserts that transparency is critical.

“In some situations, the interests of an investment fund’s security holders may conflict with those of its portfolio advisor,” states the CSA policy. “This may occur, for example, when an investment fund’s advisor also manages or seeks to manage the pension assets of a company whose securities are held by the investment fund. In these situations, an investment fund’s advisor may have an incentive to support management recommendations to further its business interests.”

Some observers have questioned why institutional investors were not more vocal when the first signs of trouble began emerging at Enron Corp., WorldCom Inc. and other scandal-ridden companies. Even if there were no direct conflicts, it is obvious that mutual funds and other institutional investors were asleep at the switch, and millions of investors worldwide are poorer
as a result.

The new rules harmonize Canadian investment fund rules with those in the U.S., which require funds to report their proxy policies and records publicly as of August.
The U.S. rules also permit funds to provide their policies and voting records online to investors through their Web sites. It is expected that as mutual funds become more comfortable with the rules, the policies and records will be widely available through the Internet. This is also a much less costly system for providing disclosure, since it won’t be necessary for funds to mail pages of spreadsheets to interested investors.

Canadian regulators would be wise to look to the U.S. rules for guidance on this point.  Compared with the current system, in which investors have no access to proxy policies and records, the new U.S. and Canadian rules will create a much more open and transparent system. Under the scrutiny of interested investors, mutual funds will formulate proxy policies to ensure their votes are cast in the best interests of unitholders.   Mutual funds will be able to compare and discuss their proxy policies openly to ensure they are comprehensive and up to date.   Unitholders will also be able to compare the policies and votes of funds as part of the process of choosing among funds.
Unitholders will also communicate with their funds on the specifics of policies and votes.

The changes will help to bring about a climate of investor democracy. Traditional fund management has emphasized passive investing. If a fund disagreed with company policies in the past, it would simply exercise the “Wall Street walk” — cashing out rather than having to deal with corporate troubles.

Increasingly, mutual funds are coming to look at themselves more as stewards than speculators. If there are fundamental issues in the way a company is managed, mutual funds and other institutional investors are bringing the issues to management’s attention. There is more willingness to engage and communicate with management over the long term rather than simply selling the stock.

By opening up the process of proxy voting to investor scrutiny, the new rules are helping to build a new climate of dialogue and discussion between corporations and the investment community.

Eugene Ellmen is executive director of the Toronto-based Social Investment Organization. 

This column appeared in the September 2004 edition of Investment Executive