Who should cast the pension proxy?

Who should cast the pension proxy?

The question is beyond nagging. Today, it's a major issue facing corporations. Should companies, as pension plan sponsors, exercise the right to vote their pension proxies or elinquish it to their investment managers? Who is better qualified to take on he voter role, if the company decides it indeed wishes to cast votes on the issues?

A panel of authorities on pension proxy voting--from corporations, the legal realm, and the Council of Institutional Investors--assembled at FEI's Treasurers Conference in February to discuss the controversy surrounding proxy voting and how companies are reacting. David E. Kelby, senior vice president and treasurer at General Mills, Inc., served as panel moderator.

PHILIP R. O'CONNELL Senior Vice President & Corporate Secretary Champion International Corporation

When ERISA was adopted in 1974, private pension fund assets were about $295 billion. These assets are now approaching $2 trillion. Pension fund assets both private and public are about $2.75 trillion now, and they represent a substantial portion of the nation's capital resources, particularly the capital available for long-term investment.

Pension funds are no longer mere pools of moneys, as they were in the early days of ERISA. They've become an economic institution, one that plays a key role in the allocation of capital in our economy. These funds have the potential to affect the economy significantly and therefore have a major impact on the well-being of our nation.

So it seems to me that pension plan sponsors must recognize this responsibility and give pension funds the kind of attention they give other major areas of corporate responsibility.

What does this mean? It means boards of directors adopt a statement of policy for the pension fund that defines its reason for being and the role it should play in the corporation. It also means a company adopts a proxy voting policy that reflects the corporate policies adopted for the pension plan by the board of directors. It doesn't make any sense for the proxy voting program of the pension fund to be at odds with the general principles of the pension fund itself.

So this involves exercising power and control over the proxy voting process by bringing all the proxies in-house to be voted. Or bringing proxies in-house on a selectives basis.

What do I mean by that? One company, for example, uses the so-called 10-day rule of the New York Stock Exchange. It helps determine when brokers can vote street name shares. There's a line drawn between those issues that are considered substantive and nonroutine and those that are considered routine. If they're nonroutine, the broker can't vote the shares for the owners.

This division in voting is an attempt to relieve what some perceive as a significant administrative burden, when each spring you get from the master trustee an annual report to shareholders, a proxy statement, and a proxy card for every equity holding in your portfolio.

Or there's a third alternative. Give the investment manager or the master trustee the fund's proxy voting policy to administer.

ERISA debates are becoming much more sophisticated. It amazes me that seasoned corporate counselors are stuck with fear at the mention of ERISA, David Walker, or the Department of Labor. Along with their clients, they assume substantial risks in acquisitions, divestitures, equal employment opportunity laws, and long-range plans. Yet they blanch at the potential liability of a defined benefit plan, in which as long as the benefits are paid it's very difficult to find a plaintiff.

Keep in mind that investment managers are solely a creature of the plan sponsor. They are delegated responsibility to form a specialized investment function. They're good at venture capital, good at real estate, or good at large or small cap companies. But plan sponsors can have this expertise in-house. They can develop it or acquire it. The power of the investment manager is all derivative. Of course, if he's given the power, he has to exercise it prudently and with loyalty to the beneficiaries and participants of the plan. But it seems to me that he has no independent reason for being in this whole conceptual scheme.

So when you consider the voting issue--and some investment managers and plan sponsors are very opposed to taking away the power to vote from investment managers--I believe we should keep in mind that all of the investment manager's powers are derived from the plan sponsor, particularly in the area of proxy voting. In fact, very few investment managers can claim expertise in voting. And, in many respects, investment managers have a built-in conflict in their voting because they are compensated according to their short-term performance.

SARAH A. B. TESLIK Executive Director Council of Institutional Investors 

Very few situations in our western economies allow one party to control someone else's property. The whole point of a market economy is that you control your own property.

There are a few exceptions, however. In the corporate context, when shareholders turn over assets for someone else to manage and then retain a very small residual group of rights, they give up control. In trust law, when someone is under age, incompetent, or a spendthrift, the legal system sometimes asks another party to control that person's property.

In the pension context, trusts have become the vehicle. Why? Because you and I do not save enough for our retirement on our own. There are always pressing reasons to spend the money now, and even if we save some, we never save enough.

That didn't matter so much when the family structure was intact, when there was no welfare state. But now it's a problem for the government. The philosophy, therefore, behind the pension system is that if we as individuals do not have enough backbone to save, perhaps we collectively will have enough. Thus, we set up trusts by which the money is taken out of our checks, it is professionally managed, it is tax favored, and it is saved for our retirement.

To decide who should vote your proxies, the first question is one of trust law. And trust law says that the beneficiary doesn't vote the assets, or else a company is dismantling the trust. Now, dismantling the trust is fine if you have a public policy reason to do so, but don't kid yourself. Don't rationalize that you are simply returning control to the actual owners.

And get out of your mind the idea that in some way the pension proxy vote is different from other decisions you make as a fiduciary. It's not. You control the trust assets, and you have to play by a set of rules, either ERISA or state rules.

Until the last few years, voting questions never came up because votes didn't matter very much. And though they now matter a bit more, they will never be as important as buying and selling decisions. And they shouldn't be. A vote is simply an asset of the plan. It's something that comes with a share of stocks, and you can use it for the beneficiaries the same way you use all the other assets: the abilities to sell to vote, to get specific information, to introduce certain kinds of shareholder proposals, to be cashed out in certain ways in mergers.

While the most important right that comes with shares of stock is the right to sell, the right to vote is important, too. You, the fiduciary, have the authority and the duty to vote. How do you carry it out? That's essentially a prudence question. Ask yourself, how would I do this best for the beneficiaries?

One pension officer at a Fortune 200 company put it this way: "Hey, there's one of me, and I've got all these proxies. What am I supposed to do with them?" A logical conclusion would be that he doesn't vote on the issues on which it would cost him more to become sufficiently educated than he could ever return by voting.

Who should vote? I think we all can say who has the legal authority to vote. But the larger that pension funds get and the bigger the chunk of the economy they hold--40 percent now and probably 50 percent in 10 years--who should vote from a public policy point of view? If, through our pension funds, we all own the economy, will we have the problems of a socialized economy, a market economy not driven by market forces but by massive piles of money where the votes ae centrally administered? These are scary questions.

Then there's the school of thinking that says the more centralized and bureaucritized the voting decisions become, the more conservative they're apt to be. How do we expect our corporations to be competitive internationally if we have an increasingly conservative group making the buying, selling, and voting decisions?

It wasn't too many years ago that proxy voting was considered by plan sponsors to be an administrative burden that was the responsibility of the investment manager. The investment manager, in turn, voted with management in almost all cases. When the manager didn't, he usually voted by selling the stock.

Several factors contribute to the increased interest in the proxy voting process: the acquisition boom of the 1980s that prompted the enactment of antitakeover provisions; activism by shareholders in the corporate governance area; and the Department of Labor's guidance that the proxy vote is a plan asset and the plan sponsor thus has a fiduciary responsibility to make sure the vote is cast in the best interest of the plan beneficiaries.

So, should the investment manager or the plan sponsor do the voting? My answer is that it doesn't really matter who does it, but rather how it is done.

I certainly don't object to plan sponsors bringing the vote in-house, assuming they establish the analytical capability necessary to do the job properly. But I doubt that many sponsors realize the amount of resources required to do so.

With many proxy issues, the real question is short-term versus long-term value. To make a voting decision, you need a thorough knowledge of the industry, the products, the strategy, and the quality of management. In short, you need to do the job that the investment manager does before he decides to buy the stock.

Here's how the proxy voting process works at GE Investments. We are a subsidiary of General Electric that oversees approximately $36 billion of assets, 95 percent of which are managed in-house. We have about $15 billion dollars in equities representing about 800 companies. And we do the proxy voting in-house on all but a small portion of this, which is in the hands of outside managers.

Voting proxies at GE Investments is a very time-consuming task that involves all 11 of our equity portfolio managers and analysts as well as several support people. In 1989, we voted nearly 2,000 issues, of which about 700 were considered nonroutine and required individual analysis.

Proxies containing nonroutine issues are assigned to the portfolio manager or analyst who has responsibility for following the industry in which the company operates. We provide guidelines that give a general framework for voting, but for the more difficult questions, the investment professional must draw upon his or her knowledge of the company and industry. This includes the credibility and track record of the management, the quality of the board of directors, and any unique characteristics of the industry.

The recommendation of the investment professional is documented and passed to the proxy review committee before the vote is cast. The review committee is made up of senior management, including me. It's responsible for developing the voting guidelines as well as reviewing any particularly controversial issues to ensure consistency of philosophy across the organization. More important, the committee ensures that the portfolio manager does not let the opportunity for short-term gain blur his or her vision of the long-term future of the company.

This approach probably is not too dissimilar from that used by most investment managers. And the investment manager is naturally equipped to do this job more easily than the plan sponsor can. He has the full-time professionals who follow the events affecting particular companies and industries on a continuing basis.

In summary, I have no conceptual problem with plan sponsors bringing the vote in-house. I just don't buy the argument that this can be done with a minimal amount of effort and cost. I don't question that there are people at the corporate level who know well the top 50 of the S&P 500 companies. But if your plan has an index fund, you may have to deal with 500 or 600 proxies. In that case, you'll need knowledge of each of these companies to do the job intelligently. I fear that this task will fast become an administrative burden and that scant attention will be paid to the long-range prospects for a company's stock price since the people making the voting decision won't be held accountable for the investment performance.

On the other hand, I don't believe it's appropriate to delegate the proxy voting responsibility totally to the investment manager without any input to the process, as I suspect some plan sponsors have done.

As an alternative, I suggest sitting down with the investment manager and devising some mutually acceptable voting guidelines. In this way, you can utilize the investment manager's resources and expertise, which you're paying for anyway. And if you aren't able to agree on guidelines with the manager, perhaps you should question how well his overall investment philosophy fits with yours.