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T. Rowe Price Investor Payback: The Unpushed Button
June 10, 2016 By
Chris Kentouris
For fund managers, proxy voting isn’t a minor housekeeping matter.
Depending on just how financially controversial the corporate agenda
is, the vote can be as crucial to the health of investor portfolios as
any trading decision. There is plenty of regulatory rulemaking to keep
everyone’s eye on the ball so when something goes awry, it’s big news.
An unintended operational mishap at T. Rowe Price, a name not
ordinarily associated with any enforcement action or scandal, has now
turned into a costly lesson. It shows that automation alone isn’t
always enough to ensure accuracy. The Baltimore-headquartered mutual
fund giant said it will compensate investors about US$194 million
which reflects the financial loss they incurred when T. Rowe Price
accidentally voted in favor of Dell Corp.’s leveraged buyout offer in
2013.
T. Rowe Price was among a group of investors that petitioned Delaware
Chancery Court Judge Travis Laster to appraise the fairness of Dell
and private equity firm silver Lake Partner’s US$13.75 a share deal.
On May 31 of this year, the judge ruled that Dell’s fair value was
really US$17.62 a share, lending credibility to T. Rowe Price’s
intention of voting against the buyout. Unfortunately, T.Rowe Price
couldn’t receive compensation from Dell, despite its intentions to
vote against it, because its recorded vote was in favor of the buyout.
T. Rowe Price’s decision to voluntarily step up to its responsibility
to make its investors whole will go a long way to mitigating the risk
of investor lawsuits. Still, the question remains: how did this very
expensive error happen?
Oops
The short answer is that T.Rowe Price neglected to manually override
the pre-programmed default vote in favor of management in
the Institutional Shareholder Services (ISS) proxy voting system. T.
Rowe Price uses the well-known third-party proxy advisory firm, to
notify it of upcoming meetings, provide voting recommendations,
collect voting instructions and convey them to Broadridge Financial.
US federal securities laws do not specifically address how an adviser
must exercise its proxy voting authority for its clients. However, in
2003 the Securities and Exchange Commission clarified that under the
Investment Advisers Act, an adviser is considered a fiduciary with the
obligation to cast proxy votes in the best interests of its clients
and disclose how it voted. Legal experts say that it is unlikely the
SEC will fine T. Rowe Price, because there is no evidence of an
intentional breach of responsibility. In 2009, the SEC fined West Palm
Beach, Fla-based INTECH Investment Manager US$300,000 and its former
chief operating officer David Hurley US$50,000 but that was for
inadequately describing its proxy voting policies and failing to
address a material conflict of interest when voting.
By comparison, the mistake made by T. Rowe Price’s back-office
reflected an unintended process snafu. The fund management firm is
accepting responsibility for its action, or inaction, but it’s
possible that what happened reflected a vulnerability caused by the
automated system. During the Delaware court hearings it was revealed
that T Rowe Price’s head of corporate governance Donna Anderson
intended to vote against the Dell LBO and the firm had, in fact, cast
its vote against the buyout offer. That vote was correctly registered
by the ISS platform.
Unfortunately, the Dell buyout was so controversial that the
shareholders meeting was postponed several times. The final
postponement changed the date of the meeting from July 2013 to
September 2013. When the date was changed in the ISS platform, the
previous vote against management disappeared and the system reverted
to the default vote in favor of management. At that point, the correct
vote against the buyout would have had to be manually re-entered by T.
Rowe Price. That didn’t happen.
Does that mean there’s a problem in the ISS voting system? Not at all.
Proxy voting experts tell FinOps Report that T. Rowe Price should have
been aware that its vote could revert to the default decision if the
meeting date changed. That is because a change in the meeting date is
considered to be equivalent to a change in agenda, requiring a re-do
of votes associated with the previous date. If someone at T. Rowe
Price should have known this, it also means that someone would have
been responsible for manually re-inputting the correct vote. It is
unclear whether that person would have been Anderson herself or one of
her colleagues. Corporate governance directors typically determine
voting policies, but often leave the actual voting to back-office
operations staff.
T Rowe Price declined to respond to FinOps’ questions as to how the
voting glitch occurred and what process changes will be made in the
future. However, media reports indicate that no one from the firm will
be fired.
ISS also would not discuss its role in the voting error, leaving
several lingering questions. Did ISS or its voting system have an
automated process to alert a client if a vote has been changed? If
not, that message might have made a difference to T. Rowe Price and
other clients who are unaware or forget that the system reverts to
default under certain circumstances. If there was an automated alert,
clearly it didn’t reach the correct party at T. Rowe Price or wasn’t
acted upon by the person who received it. In this scenario, the
mistake could come down to office turnover, ignorance of the system or
someone simply overlooking the message.
Industry Practice
Several other large mutual fund complexes contacted by FinOps
acknowledge that the Dell voting situation was ripe for error, because
of the continual change in meeting date. None of their compliance
managers wanted to discuss their specific policies but say that, in
the case of a “normal” vote where no contentious matters are
discussed, operations managers customarily rule in favor of
management. However, in the case of contentious proxy battles or other
transactions that could have an economic impact to the fund, portfolio
managers and governance managers often consult together before a final
decision is made. Often third party proxy advisory firms, such as ISS,
are consulted. Sometimes proxy advisory firms only provide voting
recommendations, sometimes they actually cast votes and other times
they do both.
In the case of “high-profile” votes, say mutual fund compliance
managers, at least two separate “back-office” individuals should
be responsible for operationally verifying that the correct vote was
cast and recorded once they receive the decision from the corporate
governance director. The corporate governance director is then
ultimately informed of each vote which must be stored and disclosed to
investors.
But what happens in the event of a change in the meeting date for a
vote? The compliance managers at the mutual fund complexes say they
have instructed their proxy voting advisory firm to separately email
the corporate governance manager and the compliance department a
notice of the change in record date and the need to review their
voting strategy or recast their vote. In the case of T Rowe Price it
could not be determined whether any of its executives were personally
notified by ISS that the meeting date for the Dell vote had changed
and more importantly the original vote against the buyout had been
deleted.
The predicament of T. Rowe Price serves as a clarion to mutual fund
managers to take a hard look at their voting procedures. It’s a harsh
reminder, for the lack of a button being pushed, millions in profits
can fly out the window. Regardless of how much effort and money is
thrown into warding off any legal damages, the event is probably also
going to cause some reputation damage among investors.
Earlier this week, T. Rowe Price’s Chief Executive Officer William
Stromberg put a positive spin on the Delaware judge’s ruling saying it
validated the firm’s investment view that the original buyout
consideration was too low. “By compensating our clients based on the
court’s ruling, clients will come out ahead as compared with how they
would have fared had they taken the merger compensation,” he adds in a
statement.
Of all the T Rowe Price funds which invested in Dell, T Rowe Price’s
Science and Technology Fund will experience the highest impact from
the additional funds — its net asset value increase the most– by 1.2
percent. Other funds impacted by the funding include its Equity Income
Fund, its Institutional Large Cap Value Fund, and its US Equities
Trust Large-Cap Value.
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