Vanguard to Turn More Activist in Proxy Voting

Vanguard Group may be best known for its “passive,” index-style investing, but the mutual fund giant said it would begin taking a more activist role in corporate governance: The firm has revamped the standards it will follow in proxy voting, putting companies on notice about key governance issues.

Longtime activist investors representing pension funds hailed the move Wednesday by the second-largest mutual fund company, though some governance experts called Vanguard’s new policies limited in scope.

Valley Forge, Pa.-based Vanguard, whose funds hold about $300 billion in stocks, posted a letter on its Web site Tuesday night that was recently sent by Chairman John J. Brennan to leaders of companies in which Vanguard holds a major stake. The letter addresses Vanguard’s new standards in such areas as director independence and stock option programs.

“We’ve always been active in corporate governance, but we’re imposing stricter guidelines in light of recent events,” Vanguard spokesman John Demming said Wednesday, referring to the spate of financial scandals that have brought down such corporate titans as Enron Corp. and WorldCom Inc., shaking investor confidence.

The mutual fund industry, which controls about $3 trillion in stock, has drawn criticism this year for failing to join the efforts of pension funds and other historically activist investors in pressing companies to change their conduct. Most fund companies have long been reluctant to get involved in such campaigns, preferring instead to jettison shares of firms that are performing poorly or whose policies stoke shareholder ire.

Among the governance issues Vanguard addressed in its letter:

* Director independence. Vanguard said that it would withhold votes for nonindependent directors who serve on audit, compensation or nominating committees of a board, and that it would not vote for any directors whose election would make the majority of a company’s board made up of insiders.

These changes dovetail with director-independence rules recently issued by the New York Stock Exchange, though the NYSE is giving companies 24 months to comply.

* Auditor independence. Vanguard will vote against a company’s auditors if non-audit fees make up more than half the total fees paid by the company to the auditing firm.

In the past, Vanguard’s policy was to support a board’s recommendation regarding directors and auditors, barring special circumstances, the firm said.

* Stock option plans. Vanguard said that it supports option plans in principle, but that it generally would vote against plans if potential dilution from options exceeds 15% of shares outstanding or if annual option grants have exceeded 2% of shares outstanding.

“We’ve been asking mutual fund companies for years to come forth and do their part for corporate governance,” said Peg O’Hara, managing director of the Council of Institutional Investors, a Washington-based group that represents 120 pension funds. “I can only hope this is the beginning of a row of dominoes in the fund industry.”

David Nygren, San Francisco-based partner at Mercer Delta, a consulting firm that works with boards and senior executives, said Vanguard “should be applauded for stepping up,” but he said the guidelines “put a limited perspective on the whole picture.”

“They focus on the material relationship, the financial issue, but not the matter of competence” of directors, he said. “This will result in more independence, but not necessarily improved performance.”

Nygren called Vanguard’s auditor policy “a little soft.” He argues that an auditing firm should not be allowed to take in any fees from consulting or other non-auditing work from a company once the firm has been hired to review the company’s books.

“The best practice would be to eliminate any perceived conflict of interest. This almost sounds like something written by an auditing firm,” Nygren said.

Vanguard’s founder and retired chairman, Jack Bogle, this year helped organize a meeting of fund managers, including Legg Mason’s William Miller, to discuss corporate reform.

But the group hasn’t issued formal proposals on governance.