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Overview

On September 2, 2005, the New York Stock Exchange (“NYSE”) filed a proposed rule change with the Securities and Exchange Commission (the “Commission”) to amend the NYSE’s interpretation of Exchange Rule 452 (Giving Proxies by Member Organizations).1 Exchange Rule 452 provides that a member organization may give a proxy to vote shares registered in its name, even if the beneficial owner fails to instruct the member how to vote, if, among other things, the proposal being voted upon does not involve a matter which “may affect substantially the rights or privileges of such stock.” The NYSE has interpreted Exchange Rule 452 to preclude a member organization from voting without instructions in certain “non-routine” situations, including on any proposal to materially amend an investment advisory contract between an investment adviser and an investment company.2 However, for many years the NYSE also has interpreted Rule 452 to permit member organizations to vote uninstructed shares on a proposal to approve a new investment advisory contract between an investment company and an investment adviser where the change in the identity of the investment adviser is the only change being made to the substantive terms of the contract.3

New Interpretation

Following discussions with the Commission’s Division of Investment Management, the NYSE decided to amend its interpretation of Exchange Rule 452. Under the new inter-pretation, proposals relating to an investment advisory contract with a new investment adviser for which the Investment Company Act of 1940, as amended (the “1940 Act”), requires shareholder approval will be deemed to be a “matter which may affect substantially the rights or privileges of such stock.” As a result, a member organization may not vote shares registered in its name on such proposals absent instructions from the beneficial owners. For example, a member organization may not vote uninstructed shares on a proposal to approve an investment advisory contract between an investment company and a new investment adviser where there has been an assignment of the investment advisory contract, including an assignment caused by a change in control of the investment adviser that is a party to the assigned contract. This interpretation applies even if the assignment of the contract will not result in a change in the identity of the adviser, (i.e., the adviser is not a “new” adviser), the management of the adviser or the portfolio managers responsible for the day-to-day management of the investment company.

Effect on Advisers and Funds

The inability of brokers to vote uninstructed shares will make it more difficult and expensive to obtain shareholder approval for investment advisory contracts. Under the 1940 Act, investment advisory contracts must be approved by the vote of the lesser of (i) 67% or more of the voting shares of the investment company present at the meeting, if the holders of more than 50% of the outstanding shares of the investment company are present in person or represented by proxy, or (ii) more than 50% of the outstanding voting shares of the investment company. Proxies for uninstructed shares submitted by a broker will, in effect, be treated as “broker non-votes”.4 Broker non-votes are considered present for purposes of determining the existence of a quorum and the number of shares of the investment company represented at the meeting, but they are not treated as affirmative votes for any proposal. As a result, proxies submitted for uninstructed shares (including broker non-votes) have the same effect as a vote against the proposal because the required vote is a percentage of the shares present or outstanding. If there are a significant number of proxies submitted for uninstructed shares (whether broker non-votes or proxies submitted indicating that pursuant to Exchange Rule 452 the broker cannot vote due to a lack of instructions), an investment company may need to adjourn the meeting to solicit additional proxies, thus increasing the cost of the proxy solicitation.5

Strategies for Addressing Rule 452

Investment companies and investment advisers contemplating proxy solicitations for approval of investment advisory contracts will need to consider strategies to increase the chances for success and control solicitation expenses. These strategies may include knowledge of the fund’s shareholder base and form of share ownership, a sufficiently lengthy solicitation period, the use of proxy solicitors to reach the maximum number of record owners and the agreement by brokers to withhold proxies for which they have not received instructions.

Footnotes

1 The proposed rule change was effective upon filing with the Commission because it merely sought to amend an interpretation of Exchange Rule 452.

2 Supplementary Material 1.1 to Rule 452.

3 SR-NYSE-2005-61, Amendment No. 1.

4 “Broker non-votes” are shares registered in a broker’s name for which instructions have not been received from the beneficial owners or persons entitled to vote and for which the broker does not have discretionary voting authority. These are submitted by the broker with an indication that they cannot vote the shares because of a lack of instruction. Proxies for uninstructed shares submitted by a broker with discretionary authority are technically not broker non-votes, because of the discretionary authority. However, they will have the same effect as broker non-votes.

5 In addition, treating broker non-votes as votes against the proposal can have the effect of causing shareholders who choose not to participate in the proxy vote to prevail over shareholders who cast votes or provide voting instructions to their brokers or nominees.

For More Information

Please contact Donald S. Mendelsohn, JoAnn M. Strasser, or Michael V. Wible or any member of our Corporate Transactions & Securities practice group for more information.

Disclosure

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