Mutual fund advisory firms have a troubling conflict of interest that may cause them to pull their punches in some proxy votes, according to SEC Commissioner Paul R. Carey.

Advisers may have their funds vote on proxy proposals in a manner favorable to company management as part of a bid by the adviser to win business, Carey said in a speech to mutual fund compliance executives and lawyers Dec. 9. For example, an adviser might have its funds make a pro-management vote in a proxy contest in an effort to win or keep the company's retirement money management business, Carey said.

"If the fund advisor wants the pension business of XYZ Company, or it wants to continue to manage XYZ's pension business, it might think twice before voting against the recommendation of XYZ's management - even if voting against the recommendation could increase the value of the funds' holdings," Carey said. "Clearly, this result is contrary to a fund advisors' fiduciary duty to the fund and its shareholders."

Carey did not cite specific examples of fund companies voting in their own interests rather than in the interest of their shareholders. But because of the concern about the conflict between the fund and the fund adviser on proxy voting, the SEC is preparing new regulations which, for the first time, will require fund advisers to disclose some information about how they vote in proxy campaigns, Carey and SEC officials said.

Carey made his remarks in a speech at the Investment Company Institute's Securities Law Developments Conference in Washington, D.C. The conference was not open to the press. The SEC made a copy of the text of Carey's speech available last week. Carey was travelling and was not available for comment.

Carey's speech took some lawyers at the conference by surprise. Although new regulations regarding adviser disclosure and registration have been in the works for more than a year, Carey's suggestion that the new rules would include added disclosure about proxies was unexpected.

Fund advisory firms routinely take steps to reduce the potential conflict between the interests of an adviser and the interests of a fund in proxy voting, lawyers and executives said last week. For example, some fund groups establish a so-called Chinese wall in which fund marketing and sales executives are kept separate from fund boards and investment managers with respect to proxy votes, fund executives said.

At Fidelity Investments of Boston, the nation's largest fund company, the funds vote on more than 5,000 proxy proposals each year, said Jessica Catino, a Fidelity spokesperson. The funds' directors each year review and approve guidelines which govern how the funds will vote, Catino said. Fidelity declined to describe its guidelines in detail. The guidelines, however, do not depend on whether Fidelity has or might have a business interest in the company making the proxy proposal, Catino said.

Carey's examination of the conflict of interest issue is not the first time the fund industry has been challenged on proxy voting recently. John Bogle, senior chairman of the Vanguard Group of Malvern, Pa., said in an Oct. 20 speech to the New York Society of Securities Analysts that mutual funds have failed to live up to their responsibility in voting their proxies. Carey made reference to the Bogle speech in his remarks on Dec. 9.

"Given the drive for corporate customers, the reluctance of fund managers to risk the opprobrium of potential clients by leaping enthusiastically into the controversial area of corporate governance is hardly astonishing, though it is discouraging," Bogle said in October.

Bogle did not return a call for comment.

Scrutiny of how funds vote their proxies will continue in the coming months. The SEC is working on rules that will revise the requirements for Form ADV, the key disclosure document which all SEC-registered investment advisers must complete. In its current form, the proposal requires that fund advisers include a description of their procedures and tendencies when it comes to voting proxies, said Cindy Fornelli, an adviser to Paul Roye, director of the SEC's division of investment management. Fornelli estimated that 35 percent of mutual funds now voluntarily disclose at least some information about their proxy procedures and preferences on the Form ADV or elsewhere in public filings.

"It's one of those proposals that I think is good for everybody," Fornelli said. "If nothing else, it sheds light on the issue so that the client knows about the adviser's (proxy voting) policy."

The SEC staff expects to forward the new rules proposal to SEC commissioners for review in the next four to six weeks, Fornelli said. The SEC hopes to adopt the new rules for the Form ADV in 2000, Fornelli said.

Mutual fund companies have been criticized for not being active in proxy voting and corporate governance issues. Fund managers are more inclined to vote with their feet than conduct a proxy fight, said Pamela Wilson, a mutual funds lawyer at Hale & Dorr in Boston. In times when financial markets are strong, managers tend to find it to be more effective to sell out of a position than to conduct a proxy fight, Wilson said.

"My guess is that activism would increase in a slightly down market," she said.

Carey acknowledged that in some instances, it makes more sense for a fund to sell rather than fight. Fund managers must weigh the costs associated with a fight or fund activism against the potential benefits that could accrue to a fund if the fight is successful, Carey said.

"Fund advisors should not expend resources if they have no reasonable expectation that doing so will provide a net benefit to the fund," Carey said.

Carey also predicted that fund companies increasingly will publish information about their proxy votes on their websites.

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