Is there a Legal Duty to Vote Shares

Simon Hartley sheds new light on a neglected area of a trustee’s duties
(taken from Isssue No 15 – April 2001

In order to explore whether and in what circumstances a legal duty could be said to apply to fiduciaries to exercise voting rights attached to their investments, it is necessary to describe the field and process of enquiry.

The first part of this article will explore the practical issues surrounding the question of any general duty to vote; the second will try to apply standard principles to the practicalities thus identified. Trustees of course have always been subject to what might for shorthand be called the `Bartlett` duty1 (being a duty to supervise, monitor and participate in control of an enterprise in which the trust has a significant stake). This is an obvious example of the trustee’s general duty of prudent stewardship but there is clearly some overlap with the narrower question of the existence of any duty to vote.

PRACTICAL ISSUES

Whose vote is it?
Public pronouncements on the subject have been bedevilled by woolly thinking and dogma2 but it is necessary to keep a clearer head. If we go back to the traditional field of trust practice, if a landed estate fiduciary owner entrusts management of the estate to a land agent and indicates that the latter will be judged on his (rental and capital) performance, the land agent would justifiably complain if the landlord conducted and closed all the rent review negotiations himself. His `intervention` – or the exercise of this particular proprietorial power – may have substantially eroded, or failed to buttress, the policies of the engaged delegate.

This illustration finds comparable expression in professional investment management. There are of course different `styles` or approaches to investment management, one being a distinction between `passive` and `active` managers. An active manager expects to identify and exploit particular situations and he will regard the vote, or the potential to vote, as an absolutely integral tool to achieve the mandate his fiduciary has set him.

The investment manager’s livelihood depends upon his performance and he is therefore perfectly entitled to ask, and the fiduciary to concede, that the vote be entrusted to him. Quite often investment management agreements makes specific provision for this, and regular report is then made by the manager of how votes have individually been cast.

For what purpose?
Case law underscores that management powers cannot be deployed to advance a political goal.3 Nor can trustees be compelled to exercise their powers to advance ethical or Christian principles.4 Nor may they exclude from the ambit of available investments for a pension scheme industries whose success might eclipse or disadvantage the industry in which their scheme beneficiaries work.5

Hence trustees may only vote as an adjunct to advancing the prospects for their invested fund and its constituents.6

To whom is `duty` owed?
It hardly needs to be said that trustees are accountable to their beneficiaries, alone. There is no wider duty recognised by the law of advancing social or political purposes, nor the claims or aspirations of non-beneficiaries. (Charity trustees, of course, must advance their objects, but, again, no broader duties are imposed.)

The chain of owners
Next it needs to be emphasised that modern investment conditions make it highly likely that there may be a chain of parties, responding one to the next and all of them subject to some fiduciary duties that are interposed between the ultimate economic beneficiary and the issuer over whose activities votes may be castable.

A charity, family trust or pension scheme may invest in the XYZ Managed Fund; the latter may invest in its affiliated, or another manager’s, UK Equity Fund; this may itself invest in a Technology Fund, and the latter may then be taking direct stakes in companies. Vote casting rights will tend to repose in the manager of the fund owning the direct stakes (in my example the Technology Fund). It is futile to berate the (ultimate) investor for not exercising voting rights in the underlying companies held at fourth hand and impossible to construct a legal duty on him to do so.

The chain of title holders
In addition to a chain of investment management fiduciaries such as described, investment holding and settlement imperatives probably then interpose a further set of participants between (in our example) the Technology Fund and the share register (legal title quoad the issuer). The Technology Fund may be under obligation to entrust safekeeping of its assets to a trustee or depositary. The latter in practice very frequently devolves securities custody to a specialist custodian, who in its turn holds `title` through an internal or external nominee, central depositary, or other market acceptable title holding vehicle or method.

Mechanics, cost and accountability
The legal right to vote can of course only be exercised at the formal behest of the voter `on the register`.

This leads on to the issue of deficient mechanics. Even if our fiduciary investor has `direct` stakes, legal title is often likely to be held in a nominee name of which, in many cases, he may quite simply be unaware. The same practice may deprive the investor of access to notice of company resolutions over which he could vote.7 Should he wish to cast a vote, this has to be arranged back through the chain to the nominee.

The process may be grudging, the investor may be charged, and, more to the point, there is no way of tracking whether, in fact, the nominee has cast the vote or that the company has registered it. There is absolutely no pattern or expectation of audit or accountability towards the vote initiator over votes recorded as cast.

The scandal of the speaking proxy
For years, institutional investors such as the National Association of Pension Funds have been drawing the attention of successive governments to a lamentable deficiency in British companies legislation. If a conscientious nominee holds a million shares in ICI for ten fiduciary investors, each with 100,000 shares, it is perfectly practicable under current mechanics for the all fiduciaries to orchestrate casting of their vote, and if the votes split 700,000; 300,000 proxies lodged by the nominee in these proportions will be effective. What companies legislation precludes is that same nominee giving a speaking proxy to any of its ten underlying clients. The reason is not that it is impossible for a nominee to give a speaking proxy, but that it can only empower one speaker8 and it cannot conscientiously vest the owner of 100,000 shares with speaking/voting proxy rights over one million. The fact that successive Governments have failed to enact this elementary reform suggests a preference for rhetoric over delivery.

Internal cost of arranging voting
I have mentioned that our conscientious investor, if he actually is able to become aware of voting issues may have to pay an administration expense to arrange for his vote to be cast. The much greater practical problem for fiduciaries is the cost of actually considering and agreeing courses of action on the topics upon which votes may have become castable.

Family trustees rarely meet more frequently than twice a year, large charities and pension schemes may have five annual meetings. The amount of time on the agenda for the totality of investment matters may be quite small, 10% or less. For voting to be meaningful, there has to be responsible consideration and, of course, there is a very narrow time window between receipt of the resolutions, and the time needed to be confident that the end nominee can receive and process the intended vote.

Consultation?
Next needs to be raised the issue of consultational responsiveness. A blithe assumption is made that the fiduciary should conscientiously consider and cast every vote, where he can. General trust principles however require fiduciaries to consult with their own beneficiaries on appropriate occasions, or pay regard to their known wishes. Not only could this principle involve fiduciaries in an expensive quest to ascertain the wishes of those whose views they feel they ought to seek, but the spectre is raised of a conflict arising between the voting judgement of the fiduciary, and the inclinations of the consultees.9

Financial service considerations
An immense irony of recent years is that while charity and family trust trustees (who would benefit from the practice) have been legislatively denied an easy route to the appointment of discretionary investment managers, the
trustees of pension schemes (which tend to be larger) have been positively discouraged from taking individual investment decisions10.    At one point the idea was trailed by a law firm that the mere act of voting regularly by pension scheme trustees infringed the legislation requiring them to have financial service authorisation to take `day to day decisions`. This overcautious view found no favour either with the regulators nor with other professionals but the fact remains that trustees of pension schemes continue to be cautious over close involvement with individual investment related decisions.

`The right to abstain`
A further feature in the debate over the last dozen years about voting is the – entirely convincing – argument that deliberate abstention on a vote itself can and does carry a message. Certainly the professional fund manager is inclined to use deliberate abstention as a way of putting down a marker with incumbent management that falls short of the public expression of opposition, with its connotations of humiliation of management or public confrontation.

GENERAL EQUITABLE PRINCIPLES

It is necessary to rehearse all these practical considerations first before analysing the underlying legal principles. The keystone is that trustees must control and safeguard their trust fund, considering diversification and suitability, exercising their stewardship with the same care a prudent man employs in looking after the funds of other people entrusted to him.11 The detailed exemplification of these principles is left in broad measure to the business judgement of the trustee.12 Where he has given the matter thought, taken appropriate advice and has not been influenced by the wrong considerations, the courts are most reluctant to substitute their judgement for his.

From these principles the following axioms can be suggested for present purposes.

1. Any duty to vote is simply part and parcel of the general trustee duty to acquaint himself with the conduct of businesses in which he has invested and to intrude upon, or control, management, where appropriate.

2.      These duties exist to advance the purposes of the trust and the economic claims of beneficiaries and not for some broader social or political dogma.

3. As part of the business judgement or latitude allowed to trustees, they may vote or refrain from voting in particular or general circumstances.

4. The practical constraints and difficulties rehearsed in this article could provide ample justification to trustees to refrain from voting.

If, despite these views, trustees are under a `duty to vote` (simpliciter – i.e. without reference to the intended exercise of proprietorial control) it is difficult to see what loss has been suffered by the beneficiary for the omission of this duty which can only be exercised for the beneficiaries benefit. It would be a case of damnum sine injuria. Any breach of trust requires restitution to the fund of the loss occasioned by the breach. No loss, no restitution.

Cautious trustees are used to passing precautionary resolutions – i.e. that they have considered diversification, or further diversification, of their trust fund but have concluded against it, and it would be an obvious step for any anxious trustees to minute from time to time (following appropriate thought and discussion) that the cost and effort of voting is disproportionate to the benefit, if any, accruing to the fund and beneficiaries.

In arguing that trustees are perfectly entitled to reach a conclusion like this, I am not for a second decrying the policies of `activist` trustees, nor of the excellent work being done by the NAPF Voting Service, the ABI and PIRC. Their efforts have achieved dramatic results in provoking the adoption of the Cadbury/Greenbury/Hempel Codes of Corporate Governance (the `Combined Code` now) – and, much more critically, enforcing their observance by otherwise autocratic management through the moral suasion of publicity13. There can be no doubt that effective governance of business and company performance are correlated. Larger funds14 have concluded that their votes, short term and long term, can play a constructive part in securing to the providers of long-term capital accountable management and a fair share of the economic cake, at an acceptable cost to them.

But a `duty to vote` – like a `Bartlett` duty – cannot be absolute, but has to be proportional. Any benefit must not be outweighed by the costs.

Simon Hartley is a partner of Richards Butler

1 Bartlett v Barclays Bank Trust Co [1980]1 All ER 139: [1988] 2 WLR 430: Trustee owned 99.8% of company but had no board representation. Management began to engage in property development which proved disastrous. Trustee liable for failure to obtain adequate flow of information and resulting inability to monitor conduct and prevent loss.

2 An example of muddled thinking was illustrated when Alistair Darling, currently Minister for Social Security, but at that point in shadow office, was urging compulsory voting by pension schemes to a pensions conference. On being asked whether his party, on attaining office, would insist on (a) all shareholders voting, and (b) all citizens voting in national and local elections, no comprehensible answer was articulated!

3 Martin v City of Edinburgh [1989] PLR 10

4 Bishop of Oxford v Church Commissioners [1992] 1 WLR 1241

5 Cowan v Scargill [1984] 2 All ER 750

6 See Hillsdown Holdings v Pensions Ombudsman [1997] 1 All ER 862 – as to improper use of trustee power for collateral purpose.

7 Other reasons why the economic owner is separated from the nominee could be the use of PEPs, ISAs, Share Options or Savings Schemes, investments ‘pledged’ to a bank or e.g. to Lloyd’s of London as additional security to support insurance underwriting

8 s.375 Companies Act 1985 allows a corporation (as shareholder) to appoint a ‘representative’. The latter exercises `the same powers` that the corporation could exercise if it were an individual shareholder.

9 One could easily imagine that the beneficiaries of a pension scheme for manual workers might have rather more restrictive views on senior management remuneration than the more business-oriented scheme trustees themselves.

10 s.191 Financial Services Act 1986 prevents trustees who are not `authorised` from taking `day to day decisions` in relation to their trust fund. `Authorisation` essentially requires membership of IMRO as an `OPS` member, conformity to the Financial Services legislation and IMRO’s extensive rule book, the establishment and observance of detailed compliance procedures and submission scrutiny by IMRO as regulator.

11 Re Whiteley (1886) 33 Ch D 347

12 The protection could be robuster still. Wight v Olswang [2001] WTLR 783. Irrespective of breaches in the decision making process, beneficiaries have no claim against a trustee for an investment decision unless they could establish that the decision was one no reasonable trustee could have made.

13 Statistics prepared by the National Association of Pension Funds suggest that each year the percentage of non-compliance by FTSE companies with the `Combined Code` has reduced by half. `Naming and shaming` works.