Proxy Voting & Other Client Obligations

Investment advisers have important obligations related to proxy voting, best execution, and trade allocation. These duties flow from the adviser's fiduciary relationship with clients.

Proxy Voting (Rule 206(4)-6)

When the Rule Applies

Rule 206(4)-6 applies when an investment adviser:

• Has voting authority over client securities (explicit or implicit)
• Exercises discretion that includes proxy voting authority
• Has not specifically excluded proxy voting from the advisory agreement

Requirements for Advisers with Voting Authority

Conflicts of Interest

Advisers must address how they handle conflicts, such as:

• Voting on securities of clients who are issuers
• Voting when adviser has business relationship with issuer
• Voting when adviser or personnel have personal interests

Use of Proxy Advisory Firms

If using a proxy advisory firm (like ISS or Glass Lewis):

• Must conduct due diligence on the firm's capabilities
• Must assess accuracy and conflicts of the firm
• Cannot blindly follow recommendations
• Ultimate responsibility remains with the adviser

Record Retention Requirements

Must maintain for 5 years:

• Proxy voting policies and procedures
• Proxy statements received (or where available)
• Records of actual votes cast
• Client requests for voting information
• Documents prepared for voting decisions

Best Execution

The Duty of Best Execution

Investment advisers have a duty to seek the most favorable terms reasonably available under the circumstances for client transactions.

Factors to Consider

Soft Dollar Arrangements

Definition: Using client commission dollars to pay for research and brokerage services.

Section 28(e) Safe Harbor: Protects advisers from breach of fiduciary duty claims if:

Eligible vs. Ineligible Services

Mixed-Use Items

For items that are partly eligible and partly ineligible:

• Must make reasonable allocation
• Only eligible portion can be paid with soft dollars
• Ineligible portion must be paid with adviser's own funds
• Documentation of allocation required

Disclosure Requirements

Soft dollar arrangements must be disclosed in:

• Form ADV Part 2A (Item 12—Brokerage Practices)
• Description of products/services received
• Description of how they benefit clients

Directed Brokerage

Client-Directed Brokerage

When a client directs the use of a particular broker:

• Client may not receive best execution
• Adviser must disclose this risk
• Client must consent to the arrangement
• Trades may cost more or execute at inferior prices

Adviser-Directed Brokerage

When an adviser directs brokerage for non-best execution reasons:

• May create conflicts of interest
• Must be disclosed
• Must still consider client interests

Trade Allocation

Fair Allocation Requirements

When an adviser manages multiple accounts with similar investment objectives:

• Must allocate trades fairly among clients
• Cannot favor certain clients over others
• Cannot allocate based on fee structure
• Must have written allocation policies

Aggregation (Bunching) of Orders

Prohibited Practices

• Favoring accounts that pay higher fees
• "Cherry-picking" profitable trades for certain accounts
• Allocating IPO shares unfairly
• Giving preferential treatment to proprietary accounts

On the Exam: Know the three-step test for Section 28(e) safe harbor for soft dollars: (1) eligible service, (2) lawful assistance in investment decisions, (3) good faith belief that commissions are reasonable. Also know that proxy voting authority creates specific compliance obligations.

Key Takeaways

• Proxy voting authority requires written policies and best-interest voting
• Best execution considers multiple factors, not just lowest cost
• Section 28(e) provides safe harbor for eligible soft dollar arrangements
• Trade allocation must be fair—no favoritism allowed
• All these obligations flow from the adviser's fiduciary duty