Management
Investment manager:
Legg Mason Partners Fund Advisor, LLC
(LMPFA)
Subadviser:
Batterymarch Financial Management, Inc. (Batterymarch)
Portfolio managers:
Stephen A. Lanzendorf, CFA, Joseph S. Giroux and Jeremy Wee, CFA. Mr. Lanzendorf (Deputy Chief
Investment Officer, Senior Portfolio Manager and Head of Batterymarchs Developed Markets Team), Mr. Giroux (Portfolio Manager) and Mr. Wee (Portfolio Manager) have been portfolio managers of the fund since its inception.
Purchase and sale of fund shares
You may purchase, redeem or exchange shares of the fund each day the New York Stock Exchange is open, at the funds net asset value determined after receipt of your request in good order,
subject to any applicable sales charge.
The funds initial and subsequent investment minimums generally are as follows:
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Investment minimum initial/additional investment ($)
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Class A
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Class C
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Class FI
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Class R
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Class I
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Class IS
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General
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1,000/50
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1,000/50
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N/A
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N/A
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1 million/None*
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N/A
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Uniform Gifts or Transfers to Minor Accounts
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1,000/50
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1,000/50
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N/A
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N/A
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1 million/None*
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N/A
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IRAs
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250/50
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250/50
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N/A
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N/A
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1 million/None*
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N/A
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SIMPLE IRAs
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None/None
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None/None
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N/A
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N/A
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1 million/None*
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N/A
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Systematic Investment Plans
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50/50
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50/50
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N/A
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N/A
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1 million/None*
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N/A
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Clients of Eligible Financial Intermediaries
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None/None
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N/A
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None/None
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N/A
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None/None
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N/A
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Eligible Investment Programs
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None/None
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N/A
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None/None
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None/None
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None/None
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N/A
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Retirement Plans with omnibus accounts held on the books of the fund and certain rollover IRAs
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None/None
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None/None
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None/None
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None/None
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None/None
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None/
None
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Other Retirement Plans
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None/None
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None/None
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N/A
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N/A
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1 million/None*
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N/A
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Institutional Investors
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1,000/50
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1,000/50
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N/A
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N/A
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1 million/None
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1 million/None
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*
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Available to investors investing directly with the fund.
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Your financial intermediary may impose different investment minimums.
For more
information about how to purchase, redeem or exchange shares, and to learn which classes of shares are available to you, you should contact your financial intermediary, or, if you hold your shares or plan to purchase shares through the fund, you
should contact the fund by phone at 1-877-721-1926 or by mail at Legg Mason Funds, P.O. Box 55214, Boston, MA 02205-8504.
Tax information
The funds distributions are taxable as ordinary income or capital gain, except when your investment is through
an IRA, 401(k) or other tax-advantaged account.
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Payments to broker/dealers and other financial intermediaries
The funds related companies may pay broker/dealers or
other financial intermediaries (such as a bank or an insurance company) for the sale of fund shares and related services. These payments create a conflict of interest by influencing your broker/dealer or other intermediary or its employees or
associated persons to recommend the fund over another investment. Ask your financial adviser or salesperson or visit your financial intermediarys or salespersons website for more information.
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More on the funds investment strategies, investments and risks
The fund seeks to provide long-term capital appreciation
and income.
Under normal circumstances, the fund invests at least 80% of its net assets, plus the amount of borrowings for investment
purposes, if any, in equity and equity-related securities that provide investment income, dividend payments or other distributions or in other investments with similar economic characteristics. The fund invests substantially all of its assets in
securities of non-U.S. issuers, including issuers in emerging markets, and may invest in issuers of any market capitalization.
The
subadviser invests only in stocks expected to pay dividends and favors stocks with lower volatility characteristics as identified by its proprietary security risk assessment process.
The subadviser uses a bottom-up approach that assesses stocks based on their individual strengths, rather than focusing on the underlying sectors/industries of those stocks or on general economic
trends. The subadviser pursues the funds investment objective by implementing an investment strategy that utilizes proprietary quantitative investment models to assist with stock selection, portfolio construction and risk control.
The subadviser seeks to manage volatility through following methods:
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Analyzing outputs from their multifactor risk model and measurements of each stocks risk relative to the overall risk of the equity markets
(beta)
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Looking for companies that offer a combination of attractive yields, high dividend growth, a record of increasing dividends and the cash flow to
support dividend payments
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Both of these types of risk measures (statistical and fundamental) are used to assist the
subadviser in constructing a portfolio of securities for the fund.
Additionally, elements of the subadvisers multi-dimensional
stock-ranking model, primarily cash-flow related factors, are used to identify securities that the subadviser believes will have less volatility than the overall equity markets.
The subadviser evaluates its investment models over time and the factors used in the models may change. The subadviser may take additional, non-quantitative factors into account when selecting
portfolio securities, including the subadvisers macroeconomic outlook.
The funds investment strategies may be changed
without shareholder approval. The funds investment objective may be changed by the Board of Trustees (the Board) without shareholder approval and on notice to shareholders.
Equity investments
Equity securities include exchange-traded and over-the-counter
(OTC) common and preferred stocks, warrants and rights, securities convertible into common stocks, securities of other investment companies and of real estate investment trusts.
Foreign investments
The fund has no geographic limits in where it may invest. The
fund may invest in both developed and emerging markets. Foreign securities may be denominated and traded in foreign currencies and may be traded in the United States or on international stock exchanges. The funds foreign investments are
typically equity securities.
Fixed income investments
Fixed income securities represent obligations of corporations, governments and other entities to repay money borrowed. Fixed income securities are commonly referred to as debt,
debt obligations, bonds or notes. The issuer of the fixed income security usually pays a fixed, variable or floating rate of interest, and repays the amount borrowed, usually at the maturity of the security. Some
fixed income
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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securities, however, do not pay current interest but are sold at a discount from their face values. Other fixed income securities may make periodic payments of interest and/or principal. Some
fixed income securities are partially or fully secured by collateral supporting the payment of interest and principal.
Currency
transactions
The fund may enter into forward foreign currency transactions to buy or sell currencies at a future date. The fund may
enter into these forward currency contracts to settle transactions in securities quoted in foreign currencies.
Derivatives and hedging
techniques
Derivatives are financial instruments whose value depends upon, or is derived from, the value of an asset, such as one or
more underlying investments, indexes or currencies. The fund may engage in a variety of transactions using derivatives, such as options on securities, futures and options on futures; forward foreign currency contracts and currency swaps. Derivatives
may be used by the fund for any of the following purposes:
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As a hedging technique in an attempt to manage risk in the funds portfolio
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As a substitute for buying or selling securities
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As a cash flow management technique
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As a means of enhancing returns
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A derivative contract will obligate or entitle the fund to deliver or receive an asset or cash payment based on the change in value of one or more investments, indexes, or currencies. When the fund
enters into derivatives transactions, it may be required to segregate assets or enter into offsetting positions, in accordance with applicable regulations. Such segregation is not a hedging technique and will not limit the funds exposure to
loss. The fund will, therefore, have investment risk with respect to both the derivative itself and the assets that have been segregated to offset the funds derivative exposure. If such segregated assets represent a large portion of the
funds portfolio, portfolio management may be affected as covered positions may have to be reduced if it becomes necessary for the fund to reduce the amount of segregated assets in order to meet redemptions or other obligations.
Swap agreements, a type of derivative contract, will tend to shift the funds investment exposure from one type of investment to another. Swap
agreements are subject to the risk that a counterparty will default on its payment obligations to the fund thereunder. If the counterparty fails to meet its obligations the fund may lose money. Swap agreements also bear the risk that the fund will
not be able to meet its obligation to the counterparty. The fund may also lose money if the underlying asset or reference does not perform as anticipated.
Equity-linked notes (ELNs)
ELNs are securities that are valued based upon the
performance of one or more equity securities traded in a foreign market, such as a stock index, a group of stocks or a single stock. ELNs offer investors the opportunity to participate in the appreciation of the underlying local equity securities
where the fund may not have established local access to that market.
Exchange- traded funds (ETFs)
The fund may invest in shares of open-end mutual funds or unit investment trusts that are traded on a stock exchange, called exchange traded funds.
Typically, an ETF seeks to track (positively or negatively) the performance of an index by holding in its portfolio either the same securities that comprise the index or a representative sample of the index. Investing in an ETF gives the fund
exposure to the securities comprising the index on which the ETF is based and the fund will gain or lose value depending on the performance of the index. Certain ETFs in which the fund may invest seek to track (positively or negatively) a multiple
of index performance on any given day.
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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More on the funds investment strategies, investments and risks contd
Exchange-traded notes
The fund may invest in exchange-traded notes or ETNs, which are debt securities that combine certain aspects of ETFs and bonds. ETNs, like ETFs, may
be traded on stock exchanges and their value depends on the performance of the underlying index and the credit rating of the issuer. ETNs may be held to maturity, but unlike bonds there are no periodic interest payments and principal is not
protected.
Real estate investment trusts (REITs)
REITs are pooled investment vehicles that invest primarily in income producing real estate or real estate related loans or interests. REITs are generally classified as equity REITs, mortgage REITs
or a combination of equity and mortgage REITs. Unlike corporations, REITs are not taxed on income distributed to their shareholders, provided they comply with the applicable requirements of the Internal Revenue Code of 1986, as amended (the
Code). The fund will indirectly bear its proportionate share of any management and other expenses that may be charged by the REITs in which it invests, in addition to the expenses paid by the fund.
Cash management
The fund may hold
cash pending investment, and may invest in money market instruments for cash management purposes. The amount of assets the fund may hold for cash management purposes will depend on market conditions and the need to meet expected redemption requests.
Defensive investing
The fund may depart from its principal investment strategies in response to adverse market, economic or political conditions by taking temporary
defensive positions in any type of money market instruments, short-term debt securities or cash without regard to any percentage limitations. Although the subadviser has the ability to take defensive positions, it may choose not to do so for a
variety of reasons, even during volatile market conditions.
Fund of funds investments
The fund may be an investment option for other Legg Mason-managed mutual funds that are managed as a fund of funds.
Other investments
The fund may
also use other strategies and invest in other securities that are described, along with their risks, in the SAI. However, the fund might not use all of the strategies and techniques or invest in all of the types of securities described in this
Prospectus or in the SAI.
More on risks of investing in the fund
Stock market and equity securities risk.
Securities fluctuate
in price based on changes in a companys financial condition and overall market and economic conditions. The value of a particular security may decline due to factors that affect a particular industry or industries, such as an increase in
production costs, competitive conditions or labor shortages; or due to general market conditions, such as real or perceived adverse economic conditions, changes in the general outlook for corporate earnings, changes in interest or currency rates or
generally adverse investor sentiment.
Foreign investments and
emerging markets risk.
The funds investments in securities of foreign issuers or issuers with significant exposure to foreign markets involve additional risk. Foreign
countries in which the fund may invest may have markets that are less liquid, less regulated and more volatile than U.S. markets. The value of the funds investments may decline because of factors affecting the particular issuer as well as
foreign markets and issuers generally, such as unfavorable government actions, and political or financial instability. Lack of information may also affect the value of these securities.
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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The value of the funds foreign investments may also be affected by foreign tax laws, special
U.S. tax considerations and restrictions on receiving the investment proceeds from a foreign country. Dividends or interest on, or proceeds from the sale of, foreign securities may be subject to non-U.S. withholding taxes.
In some foreign countries, less information is available about issuers and markets because of less rigorous accounting and regulatory standards than
in the United States. It may be difficult for the fund to pursue claims against a foreign issuer in the courts of a foreign country. Some securities issued by non-U.S. governments or their subdivisions, agencies and instrumentalities may not be
backed by the full faith and credit of such governments. Even where a security is backed by the full faith and credit of a government, it may be difficult for the fund to pursue its rights against the government. Some non-U.S. governments have
defaulted on principal and interest payments, and more may do so.
The risks of foreign investments are heightened when investing in
issuers in emerging market countries. Emerging market countries tend to have economic, political and legal systems that are less fully developed and are less stable than those of more developed countries. They are often particularly sensitive to
market movements because their market prices tend to reflect speculative expectations. Low trading volumes may result in a lack of liquidity and in extreme price volatility. Investors should be able to tolerate sudden, sometimes substantial,
fluctuations in the value of their investments. Emerging market countries may have policies that restrict investment by foreigners or that prevent foreign investors from withdrawing their money at will. An investment in emerging market
securities should be considered speculative.
Currency
risk.
The value of investments in securities denominated in foreign currencies increases or decreases as the rates of exchange between those currencies and the U.S. dollar change.
Currency conversion costs and currency fluctuations could erase investment gains or add to investment losses. Currency exchange rates can be volatile, and are affected by factors such as general economic conditions, the actions of the U.S. and
foreign governments or central banks, the imposition of currency controls and speculation.
Issuer risk.
The value of a security can be more volatile than the market as a whole and can perform differently from the value
of the market as a whole. The value of a companys securities may deteriorate because of a variety of factors, including disappointing earnings reports by the issuer, unsuccessful products or services, loss of major customers, major litigation
against the issuer or changes in government regulations affecting the issuer or the competitive environment.
Dividend-paying stock risk.
The funds emphasis on dividend-paying stocks involves the risk that such stocks may fall out
of favor with investors and underperform the market. Also, a company may reduce or eliminate its dividend.
Large capitalization company risk.
Large capitalization companies may fall out of favor with investors.
Small and medium capitalization company risk.
The fund will be exposed to additional risks as a result of its investments in the securities of small and medium capitalization companies. Small and medium capitalization companies may fall out of
favor with investors; may have limited product lines, operating histories, markets or financial resources; or may be dependent upon a limited management group. The prices of securities of small and medium capitalization companies generally are more
volatile than those of large capitalization companies and are more likely to be adversely affected than large capitalization companies by changes in earnings results and investor expectations or poor economic or market conditions, including those
experienced during a recession. Securities of small and medium capitalization companies may underperform large capitalization companies, may be harder to sell at times and at prices the portfolio managers believe appropriate and may offer greater
potential for losses.
Liquidity risk.
Liquidity risk exists when particular investments are difficult to sell. Although most of the funds investments must be liquid at the time of investment, investments may become illiquid after
purchase by the fund, particularly during periods of market turmoil. When the fund holds illiquid investments, including investments in non-public companies, the portfolio may be harder to value, especially in changing markets, and if the fund is
forced to sell these investments to meet redemption requests or for other cash
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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More on the funds investment strategies, investments and risks contd
needs, the fund may suffer a loss. In addition, when there is illiquidity in the market for certain investments, the fund, due to limitations on illiquid investments, may be unable to achieve its
desired level of exposure to a certain sector.
Derivatives
risk.
Using derivatives, especially for non-hedging purposes, may involve greater risks to the fund than investing directly in securities, particularly as these instruments may be
very complex and may not behave in the manner anticipated. Certain derivatives transactions may have a leveraging effect on the fund. Even a small investment in derivative contracts can have a significant impact on the funds stock market or
currency exposure. Therefore, using derivatives can disproportionately increase losses and reduce opportunities for gains when stock prices or currency rates are changing. The fund may not fully benefit from or may lose money on derivatives if
changes in their value do not correspond as anticipated to changes in the value of the funds holdings. Using derivatives may increase the funds volatility, which is the degree to which the funds share price may fluctuate within a
short time period. Holdings of derivatives also can make the fund less liquid and harder to value, especially in declining markets. The fund may incur additional costs related to derivatives, such as transaction costs and custody expenses, which can
adversely affect the funds performance.
Derivatives are subject to counterparty risk, which is the risk that the other party in
the transaction will not fulfill its contractual obligation.
Recent legislation calls for new regulation of the derivatives
markets. The extent and impact of the regulation are not yet fully known and may not be for some time. New regulation of derivatives may make them more costly, may limit their availability, or may otherwise adversely affect their value or
performance.
Risks associated with the use of derivatives are magnified to the extent that a large portion of the funds assets are
committed to derivatives in general or are invested in just one or a few types of derivatives.]
Currency transactions risk.
The fund may not fully benefit from or may lose money on forward currency transactions if changes
in currency exchange rates do not occur as anticipated or do not correspond accurately to changes in the value of the funds holdings.
The funds ability to use forward foreign currency transactions successfully depends on a number of factors, including the forward foreign currency transactions being available at prices that
are not too costly, the availability of liquid markets and the ability of the portfolio managers to accurately predict the direction of changes in currency exchange rates. Currency exchange rates may be volatile and may be affected by, among other
factors, the general economics of a country, the actions of U.S. and foreign governments or central banks, the imposition of currency controls and speculation. A security may be denominated in a currency that is different from the currency where the
issuer is domiciled.
Currency transactions are subject to counterparty risk, which is the risk that the other party in the transaction
will not fulfill its contractual obligation.
Portfolio turnover
risk.
Active and frequent trading may lead to the realization and distribution to shareholders of higher short-term capital gains, which would increase their tax liability. Frequent
trading also increases transaction costs, which could detract from the funds performance.
Volatility risk.
The value of the securities in the funds portfolio may fluctuate, sometimes rapidly and unpredictably.
The value of a security may fluctuate due to factors affecting markets generally or particular industries. The value of a security may also be more volatile than the market as a whole. This volatility may affect the funds net asset value.
Although the subadvisers models were created to invest in stocks that exhibit low volatility characteristics, there is no guarantee that these models and strategies will be successful. Securities in the funds portfolio may be subject to
price volatility and the prices may not be any less volatile than the market as a whole and could be more volatile. Events or financial circumstances affecting individual securities or sectors may increase the volatility of the fund.
ETFs risk.
Investing in an ETF will give the fund exposure to the securities comprising the index on which the ETF is based and will expose the fund to risks similar to those of investing directly in those securities.
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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Unlike shares of typical mutual funds or unit investment trusts, shares of ETFs are traded on an exchange and may trade throughout a trading day. ETFs are bought and sold based on market values
and not at net asset value, and therefore, may trade at either a premium or discount to net asset value. However, the trading prices of index-based ETFs tend to closely track the actual net asset value of the underlying portfolios. The fund will
generally gain or lose value on holdings of an ETF consistent with the performance of the index on which the ETF is based. The fund will pay brokerage commissions in connection with the purchase and sale of shares of ETFs.
Equity-linked notes risk.
ELNs are generally subject to the same risks as the foreign equity securities or the basket of foreign securities to which they are linked. If the linked securities decline in value, the ELN
may return a lower amount at maturity.
ELNs involve further risks associated with purchases and sales of notes, including the exchange
rate fluctuations and a decline in the credit quality of the notes issuer.
ELNs are frequently secured by collateral. If an issuer
defaults, the fund would look to any underlying collateral to recover its losses. Ratings of issuers of ELNs refer only to the issuers creditworthiness and the related collateral. They provide no indication of the potential risks of the linked
securities.
REITs risk.
Investments in REITs expose the fund to risks similar to investing directly in real estate. The value of these underlying investments may be affected by changes in the value of the underlying real
estate, the quality of the property management, the creditworthiness of the issuer of the investments, and changes in property taxes, interest rates and the real estate regulatory environment. Investments in REITs are also affected by general
economic conditions. Certain REITs charge management fees, which may result in layering the management fees paid by the fund. REITs may be leveraged, which increases risk.
Portfolio selection risk.
The value of your investment may
decrease if the subadvisers judgment about the attractiveness, value, or market trends affecting a particular security, industry or sector or about market movements is incorrect.
Valuation risk.
Many factors may influence the price at which
the fund could sell any particular portfolio investment. The sales price may well differhigher or lowerfrom the funds last valuation, and such differences could be significant, particularly for illiquid securities and securities
that trade in relatively thin markets and/or markets that experience extreme volatility. If market conditions make it difficult to value some investments, the fund may value these investments using more subjective methods, such as fair value
methodologies. Investors who purchase or redeem fund shares on days when the fund is holding fair-valued securities may receive a greater or lesser number of shares, or greater or lower redemption proceeds, than they would have received if the fund
had not fair-valued the security or had used a different valuation methodology. The value of foreign securities, certain fixed income securities and currencies, as applicable, may be materially affected by events after the close of the market on
which they are valued, but before the fund determines its net asset value.
Cash management and defensive investing risk.
The value of the investments held by the fund for cash management or defensive investing purposes can fluctuate. Like other fixed income securities, they are subject to risk, including market,
interest rate, and credit risk. If the fund holds cash uninvested it will be subject to the credit risk of the depository institution holding the cash. If the fund holds cash uninvested, the fund will not earn income on the cash. If a significant
amount of the funds assets are used for cash management or defensive investing purposes, it may not achieve its investment objective.
Risk of increase in expenses.
Your actual costs of investing in
the fund may be higher than the expenses shown in Annual fund operating expenses for a variety of reasons. For example, expense ratios may be higher than those shown if a fee limitation is changed or terminated or if average net assets
decrease. Net assets are more likely to decrease and fund expense ratios are more likely to increase when markets are volatile.
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More on the funds investment strategies, investments and risks contd
Recent market events risk.
The equity and debt capital markets in the United States and internationally have experienced unprecedented volatility. The financial crisis that began in 2008 has caused a significant decline in
the value and liquidity of many securities; in particular, the values of some sovereign debt and of securities of issuers that invest in sovereign debt and related investments have fallen, credit has become more scarce worldwide and there has been
significant uncertainty in the markets. This environment could make identifying investment risks and opportunities especially difficult for the subadviser. These market conditions may continue or get worse. In response to the crisis, the U.S. and
other governments and the Federal Reserve and certain foreign central banks have taken steps to support financial markets. The withdrawal of this support, failure of efforts to respond to the crisis, or investor perception that such efforts are
not succeeding could also negatively affect financial markets generally as well as the value and liquidity of certain securities. In addition, policy and legislative changes in the United States and in other countries are changing many aspects of
financial regulation. The impact of these changes on the markets, and the practical implications for market participants, may not be fully known for some time.
Please note that there are other factors that could adversely affect your investment and that could prevent the fund from achieving its investment objective. More information about risks appears in
the SAI. Before investing, you should carefully consider the risks that you will assume.
Portfolio holdings
A description of the funds policies and procedures with respect to the disclosure of its portfolio holdings is available in the SAI.
The fund posts its complete portfolio holdings at http://www.leggmason.com/individualinvestors/prospectuses (click on the name of the fund) on a quarterly basis. The fund intends to post its complete portfolio holdings 14 calendar days following the
quarter-end. The fund intends to post partial information concerning the funds portfolio holdings (such as top 10 holdings or sector breakdowns, for example) on the Legg Mason funds website on a monthly basis. The fund intends to post
this partial information 10 business days following each month-end. Such information will remain available until the next months or quarters holdings are posted.
More on fund management
Legg Mason Partners
Fund Advisor, LLC (LMPFA or the manager) is the funds investment manager. LMPFA, with offices at 620 Eighth Avenue, New York, New York 10018, also serves as the investment manager of other Legg Mason-sponsored
funds. LMPFA provides administrative and certain oversight services to the fund. LMPFA was formed in April 2006 as a result of an internal reorganization to consolidate advisory services after Legg Mason, Inc. (Legg Mason) acquired
substantially all of Citigroups asset management business in December 2005. As of December 31, 2012, LMPFAs total assets under management were approximately $[ ]
billion.
Batterymarch Financial Management, Inc. (Batterymarch or the subadviser) provides the day-to-day
portfolio management of the fund, except for the management of cash and short-term instruments. Batterymarch has offices at John Hancock Tower, 200 Clarendon Street, Boston, Massachusetts 02116. Batterymarch provides asset management services
primarily for institutional accounts, such as corporate pension and profit sharing plans; endowments and foundations; investment companies (including mutual funds); and state, municipal and foreign governmental entities. As of December 31,
2012, Batterymarchs total assets under management were approximately $[ ] billion.
Western Asset Management Company (Western
Asset) manages the funds cash and short-term instruments. Western Asset, established in 1971, has offices at 385 East Colorado Boulevard, Pasadena, California 91101 and 620 Eighth Avenue, New York, New York 10018. Western Asset
acts as investment adviser to institutional accounts, such as corporate pension plans, mutual funds and endowment funds. As of December 31, 2012, the total assets under management of Western Asset and its supervised affiliates were
approximately $[ ] billion.
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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LMPFA, Batterymarch and Western Asset are wholly-owned subsidiaries of Legg Mason. Legg Mason, whose
principal executive offices are at 100 International Drive, Baltimore, Maryland 21202, is a global asset management company. As of December 31, 2012, Legg Masons asset management operations had aggregate assets under management of
approximately $[ ] billion.
Portfolio managers
Batterymarchs Developed Markets Team provides management support for this fund. At Batterymarch, all portfolios are managed on a collaborative
basis using a systematic, rules-based approach. The portfolio managers oversee the effectiveness of the overall investment process, including stock ranking and selection, portfolio construction and trading, and review trades before execution.
Members of the investment team may change from time to time.
Stephen A. Lanzendorf, CFA,, Joseph S. Giroux and Jeremy Wee, CFA have
leadership responsibility for the day-to-day management of the fund. They are responsible for the strategic oversight of the funds investments. Their focus is on portfolio structure, and they are primarily responsible for ensuring that the
fund complies with its investment objective, guidelines and restrictions, and Batterymarchs current internal investment strategies. Messrs Lanzendorf, Giroux and Wee have been portfolio managers of the fund since its inception.
Mr. Lanzendorf, CFA, is Deputy Chief Investment Officer, Head of Batterymarchs Developed Markets Team and a Senior Portfolio
Manager and has 27 years of investment experience. He joined Batterymarch in 2006. Mr. Lanzendorf was previously employed at Independence Investments LLC from 1994 to 2005 where he most recently served as director of Quantitative Strategies
from 1999 to 2005. He has a B.S. and M.S. from the Massachusetts Institute of Technology.
Mr. Giroux, Portfolio Manager, has 19
years of experience in the investment industry. He joined Batterymarch in 2012. Mr. Giroux previously managed both U.S. and non-U.S. assets for several firmsGolden Capital Management, Wells Capital Management and Evergreen
Investmentsthat were affiliated with or acquired by Wells Fargo. He was also a portfolio manager at TriPoint Asset Management and The Boston Company Asset Management. He has a B.S. from New England Institute of Technology and completed
graduate coursework at Brown University.
Mr. Wee, CFA, Portfolio Manager, has 14 years of experience in the investment industry. He
joined Batterymarch in 2012. Prior to Batterymarch, Mr. Wee was a principal and lead quantitative analyst at Blackstone and served as vice president of quantitative research at Legg Mason, Inc. (formerly Citigroup Asset Management). He was also
a global money market dealer at Dresdner Kleinwort Benson in Singapore. Jeremy. He holds a BSE from the University of Michigan and an MBA from the MIT Sloan School of Management
The SAI provides information about the compensation of the portfolio managers, other accounts managed by the portfolio managers and any fund shares held by the portfolio managers.
Management fee
As compensation for
its management services, LMPFA is entitled to receive from the fund a fee of [ ]% of the funds average daily net assets.
A discussion regarding the basis for the Boards approval of the funds management agreement and subadvisory agreements will be available
in the funds first shareholder report.
Expense limitation
The manager has agreed to waive fees and/or reimburse operating expenses (other than interest, brokerage, taxes and extraordinary expenses) so that total annual operating expenses are not expected
to exceed [ ]% for Class A shares, [ ]% for Class C shares,
[ ]% for Class FI shares, [ ]% for Class R shares,
[ ]% for Class I shares and [ ]% for Class IS shares, subject to recapture as described below. This
arrangement is expected to continue until December 31, 2014, may be terminated prior to that date by agreement of the manager and the Board, and may be terminated at any time after that
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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More on fund management contd
date by the manager. This arrangement, however, may be modified by the manager to decrease total annual operating expenses at any time. The manager is also permitted to recapture amounts waived
and/or reimbursed to the class during the same fiscal year if the class total annual operating expenses have fallen to a level below the limit described above. In no case will the manager recapture any amount that would result, on any
particular business day of the fund, in the class total annual operating expenses exceeding the applicable limit or any other lower limit then in effect.
Distribution
LMIS, a wholly-owned broker/dealer subsidiary of Legg Mason, serves as
the funds sole and exclusive distributor.
The fund has adopted a Rule 12b-1 shareholder services and distribution plan. Under the
plan, the fund pays distribution and/or service fees based on annualized percentages of average daily net assets, of up to 0.25% for Class A shares; up to 1.00% for Class C shares; up to 0.25% for Class FI shares; and up to 0.50% for Class R
shares. These fees are an ongoing expense and, over time, will increase the cost of your investment and may cost you more than other types of sales charges. Class I shares and Class IS shares are not subject to distribution and/or service fees under
the plan.
In addition, the distributor, the manager and/or their affiliates make payments for distribution, shareholder servicing,
marketing and promotional activities and related expenses out of their profits and other available sources, including profits from their relationships with the fund. These payments are not reflected as additional expenses in the fee table
contained in this Prospectus. The recipients of these payments may include the funds distributor and affiliates of the manager, as well as non-affiliated broker/dealers, insurance companies, financial institutions and other financial
intermediaries through which investors may purchase shares of the fund, including your financial intermediary. The total amount of these payments is substantial, may be substantial to any given recipient and may exceed the costs and expenses
incurred by the recipient for any fund-related marketing or shareholder servicing activities. The payments described in this paragraph are often referred to as revenue sharing payments. Revenue sharing arrangements are separately
negotiated.
Revenue sharing payments create an incentive for an intermediary or its employees or associated persons to recommend or sell
shares of the fund to you. Contact your financial intermediary for details about revenue sharing payments it receives or may receive. Revenue sharing payments, as well as payments under the shareholder services and distribution plan (where
applicable), also benefit the manager, the distributor and their affiliates to the extent the payments result in more assets being invested in the fund on which fees are being charged.
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Choosing a class of shares to buy
Individual investors can generally invest in Class A and Class C
shares. Individual investors who invest directly with the fund and who meet the $1,000,000 minimum investment requirement may purchase Class I shares.
Retirement Plan and Institutional Investors and Clients of Eligible Financial Intermediaries should refer to Retirement and Institutional Investors eligible investors below for a
description of the classes available to them. Each class has different sales charges and expenses, allowing you to choose a class that may be appropriate for you.
When choosing which class of shares to buy, you should consider:
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How much you plan to invest
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How long you expect to own the shares
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The expenses paid by each class detailed in the fee table and example for each fund at the front of this Prospectus
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Whether you qualify for any reduction or waiver of sales charges
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Availability of share classes
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When choosing between Class A and Class C shares, you should be aware that, generally speaking, the larger the size of your investment and the longer your investment horizon, the more likely it
will be that Class C shares will not be as advantageous as Class A shares. The annual distribution and/or service fees on Class C shares may cost you more over the longer term than the front-end sales charge and service fees you would have paid
for larger purchases of Class A shares. If you are eligible to purchase Class I shares, you should be aware that Class I shares are not subject to a front-end sales charge and generally have lower annual expenses than Class A or Class C
shares.
Each class of shares, except Class IS shares, is authorized to pay fees for recordkeeping services to Service Agents. As a
result, operating expenses of classes that incur new or additional recordkeeping fees may increase over time.
You may buy shares:
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Through banks, brokers, dealers, insurance companies, investment advisers, financial consultants or advisers, mutual fund supermarkets and other
financial intermediaries that have entered into an agreement with the distributor to sell shares of the fund (each called a Service Agent)
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Your Service Agent may provide shareholder services that differ from the services provided by other Service Agents. Services provided by your Service Agent may vary by class. You should ask your
Service Agent to explain the shareholder services it provides for each class and the compensation it receives in connection with each class. Remember that your Service Agent may receive different compensation depending on the share class in which
you invest.
Your Service Agent may not offer all classes of shares. You should contact your Service Agent for further information.
More information about the funds classes of shares is available through the Legg Mason funds website. Youll find
detailed information about sales charges and ways you can qualify for reduced or waived sales charges, including:
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The front-end sales charges that apply to the purchase of Class A shares
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The contingent deferred sales charges that apply to the redemption of Class C shares and certain Class A shares
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Who qualifies for lower sales charges on Class A shares
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Who qualifies for a sales load waiver
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To visit the website, go to http://www.leggmason.com/individualinvestors/products, and click on the name of the fund in the dropdown menu.
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Comparing the funds classes
The following table compares key features of the funds classes.
You should review the fee table and example for each fund at the front of this Prospectus carefully before choosing your share class. Your Service Agent can help you choose a class that may be appropriate for you. Please contact your Service Agent
regarding the availability of Class FI or Class R shares. You may be required to provide appropriate documentation confirming your eligibility to invest in Class FI or Class R shares. Your Service Agent may receive different compensation depending
upon which class you choose.
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Key features
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Initial sales charge
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Contingent deferred
sales charge
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Annual distribution and/
or service fees
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Exchange
privilege
1
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Class
A
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Initial sales charge
You may qualify for
reduction or waiver of initial sales charge
Generally lower annual expenses than Class C
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Up to 5.75%; reduced or waived for large purchases and certain investors. No charge for purchases of $1 million or more
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1.00% on purchases of $1 million or more if you redeem within 18 months of purchase (or within 12 months for shares purchased prior to
August 1, 2012); waived for certain investors
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0.25% of average daily net assets
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Class A shares of funds sold by the distributor
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Class
C
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No initial sales charge
Contingent deferred sales charge for only 1 year
Does not convert to Class
A
Generally higher annual
expenses than Class A
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None
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1.00% if you redeem within 1 year of purchase; waived for certain investors
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1.00% of average daily net assets
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Class C shares of funds sold by the distributor
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Class
FI
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No initial or contingent deferred sales charge
Only offered to Clients of Eligible Financial Intermediaries and eligible Retirement
Plans
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None
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None
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0.25% of average daily net assets
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Class FI shares of funds sold by the
distributor
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Class
R
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No initial or contingent deferred sales charge
Only offered to eligible Retirement Plans with omnibus accounts held on the books of the fund,
Clients of Eligible Financial Intermediaries and Eligible Investment Program
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None
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None
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0.50% of average daily net assets
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Class R shares of funds sold by the distributor
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Class
I
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No initial or contingent deferred sales charge
Only offered to institutional and other eligible investors
Generally lower annual
expenses than all classes except Class IS
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None
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None
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None
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Class I shares of funds sold by the distributor
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Key features
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Initial sales charge
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Contingent deferred
sales charge
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Annual distribution and/
or service fees
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Exchange
privilege
1
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Class
IS
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No initial or contingent deferred sales charge
Only offered to institutional and other eligible investors
Generally lower annual
expenses than the other classes
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None
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None
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None
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Class IS shares of funds sold by the distributor
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1
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Ask your Service Agent about the funds available for exchange.
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Sales charges
Class A shares
You buy Class A shares at the offering price, which is the net asset value plus a sales charge. You pay a lower rate as the size of your investment increases to certain levels called
breakpoints. You do not pay a sales charge on the funds distributions or dividends that you reinvest in additional Class A shares.
The table below shows the rate of sales charge you pay, depending on the amount you purchase. It also shows the amount of broker/dealer compensation that will be paid out of the sales charge if you
buy shares from a Service Agent. For Class A shares sold by the distributor, the distributor will receive the sales charge imposed on purchases of Class A shares (or any contingent deferred sales charge paid on redemptions) and will retain
the full amount of such sales charge. Service Agents will receive a distribution and/or service fee payable on Class A shares at an annual rate of up to 0.25% of the average daily net assets represented by the Class A shares serviced by
them.
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Amount of Investment
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Sales charge
as % of
offering price
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Sales charge
as % of net
amount
invested
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Broker/dealer
commission as
% of
offering price
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Less than $25,000
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5.75
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6.10
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5.00
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$25,000 but less than $50,000
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5.00
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5.26
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4.25
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$50,000 but less than $100,000
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4.50
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4.71
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3.75
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$100,000 but less than $250,000
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3.50
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3.63
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2.75
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$250,000 but less than $500,000
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2.50
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2.56
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2.00
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$500,000 but less than $750,000
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2.00
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2.04
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1.60
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$750,000 but less than $1 million
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1.50
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1.52
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1.20
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$1 million or more
1
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-0-
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-0-
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up to 1.00
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1
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The distributor may pay a commission of up to 1.00% to a Service Agent for purchase amounts of $1 million or more. In such cases, starting in the
thirteenth month after purchase, the Service Agent will also receive an annual distribution and/or service fee of up to 0.25% of the average daily net assets represented by the Class A shares held by its clients. Prior to the thirteenth month,
the distributor will retain this fee. Where the Service Agent does not receive the payment of this commission, the Service Agent will instead receive the annual distribution and/or service fee starting immediately after purchase. Please contact your
Service Agent for more information.
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Investments of $1,000,000 or more
You do not pay an initial sales charge when you buy $1,000,000 or more of Class A shares. However, if you redeem these Class A shares
within 18 months of purchase (or within 12 months for shares purchased prior to August 1, 2012), you will pay a contingent deferred sales charge of 1.00%.
Qualifying for a reduced Class A sales charge
There are several ways you can
combine multiple purchases of Class A shares of funds sold by the distributor to take advantage of the breakpoints in the sales charge schedule. In order to take advantage of reductions in sales charges that may be available to you when you
purchase fund shares, you must inform your Service Agent or the fund if you are eligible for a letter of intent or a right of accumulation and if you own shares of other funds that are eligible to be aggregated with your purchases. Certain records,
such as account statements, may be necessary in order to verify your eligibility for a reduced sales charge.
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Accumulation Privilege
allows you to combine the current value of Class A shares of the fund with other shares of funds
sold by the distributor that are owned by:
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your spouse, and children under the age of 21
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with the dollar amount of your next purchase of Class A shares for purposes of calculating the initial sales charges.
If you hold fund shares in accounts at two or more Service Agents, please contact your Service Agents to determine which shares may be combined.
For purposes of the accumulation privilege:
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You can combine shares of funds sold by the distributor that are offered with a sales charge, which includes shares of money market funds sold by
the distributor that were acquired by exchange from other funds offered with a sales charge.
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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You may generally not combine shares of other funds that are not offered with a sales charge. For example, shares of money market funds sold by
the distributor that were not acquired by exchange from other funds offered with a sales charge may not be combined.
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Certain exceptions may apply. Please contact your Service Agent for additional information.
Certain trustees and fiduciaries may be entitled to combine accounts in determining their sales charge.
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Letter of Intent
allows you to purchase Class A shares of funds sold by the distributor over a 13-month period and pay
the same sales charge, if any, as if all shares had been purchased at once. At the time you enter into the letter of intent, you select your asset goal amount. Generally, purchases of shares of funds sold by the distributor that are purchased during
the 13-month period by:
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your spouse, and children under the age of 21
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are eligible for inclusion under the letter of intent, based on the public offering price at the time of the purchase and any capital appreciation on those shares. In addition, you can include the
current value of any eligible holdings toward your asset goal amount.
If you hold shares of funds sold by the distributor in accounts at
two or more Service Agents, please contact your Service Agents to determine which shares may be credited toward your asset goal amount.
Shares of money market funds sold by the distributor acquired by exchange from other funds offered with a sales charge may be credited toward your
asset goal amount. Please contact your Service Agent for additional information.
If you do not meet your asset goal amount, shares in
the amount of any sales charges due, based on the amount of your actual purchases, will be redeemed from your account.
Waivers for
certain Class A investors
Class A initial sales charges are waived for certain types of investors, including:
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Employees of Service Agents
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Investors who redeemed Class A shares of a fund sold by the distributor in the past 60 days, if the investors Service Agent is
notified
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Directors and officers of any Legg Mason-sponsored fund
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Employees of Legg Mason and its subsidiaries
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Investors investing through certain Retirement Plans
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Investors who rollover fund shares from a qualified retirement account administered on the same retirement platform
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If you qualify for a waiver of the Class A initial sales charge, you must notify your Service Agent or the fund at 1-877-721-1926 at the time
of purchase and provide sufficient information at the time of purchase to permit verification that the purchase qualifies for the initial sales charge waiver.
If you want to learn about additional waivers of Class A initial sales charges, contact your Service Agent, consult the SAI or visit the Legg Mason funds website,
http://www.leggmason.com/individualinvestors/products, and click on the name of the fund in the dropdown menu.
Class C shares
You buy Class C shares at net asset value with no initial sales charge. However, if you redeem your Class C shares within one
year of purchase, you will pay a contingent deferred sales charge of 1.00%.
LMIS generally will pay Service Agents selling Class C
shares a commission of up to 1.00% of the purchase price of the Class C shares they sell. LMIS will retain the contingent deferred sales charges and an annual distribution and/or service fee of up to 1.00% of the average daily net assets
represented by the Class C shares serviced by these Service Agents until the thirteenth month after purchase. Starting in the thirteenth
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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Sales charges contd
month after purchase, these Service Agents will receive an annual distribution and/or service fee of up to 1.00% of the average daily net assets represented by the Class C shares serviced by
them.
Class FI and Class R shares
You buy Class FI and Class R shares at net asset value with no initial sales charge and no contingent deferred sales charge when redeemed.
Service Agents receive an annual distribution and/or service fee of up to 0.25% of the average daily net assets represented by Class FI shares
serviced by them and up to 0.50% of the average daily net assets represented by Class R shares serviced by them.
Class I and Class
IS shares
You buy Class I and Class IS shares at net asset value with no initial sales charge and no contingent deferred sales charge
when redeemed. Class I and Class IS shares are not subject to any distribution and/or service fees.
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More about contingent deferred sales charges
The contingent deferred sales charge is based on the net asset value at
the time of purchase or redemption, whichever is less, and therefore you do not pay a sales charge on amounts representing appreciation or depreciation.
In addition, you do not pay a contingent deferred sales charge:
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When you exchange shares for shares of another fund sold by the distributor
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On shares representing reinvested distributions and dividends
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On shares no longer subject to the contingent deferred sales charge
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Each time you place a request to redeem shares, the fund will first redeem any shares in your account that are not subject to a contingent deferred sales charge and then redeem the shares in your
account that have been held the longest.
If you redeem shares of the fund sold by the distributor and pay a contingent deferred sales
charge, you may, under certain circumstances, reinvest all or part of the redemption proceeds within 60 days and receive pro rata credit for any contingent deferred sales charge imposed on the prior redemption. Please contact your Service Agent
for additional information.
The distributor receives contingent deferred sales charges as partial compensation for its expenses in
selling shares, including the payment of compensation to your Service Agent.
Contingent deferred sales charge waivers
The contingent deferred sales charge for each share class will generally be waived:
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On payments made through certain systematic withdrawal plans
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On certain distributions from a Retirement Plan
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For Retirement Plans with omnibus accounts held on the books of the fund
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For involuntary redemptions of small account balances
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For 12 months following the death or disability of a shareholder
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If you want to learn more about additional waivers of contingent deferred sales charges, contact your Service Agent, consult the SAI or visit the Legg Mason funds website,
http://www.leggmason.com/individualinvestors/products, and click on the name of the fund in the dropdown menu.
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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Retirement and Institutional Investors eligible investors
Retirement Plans
Retirement Plans include 401(k) plans, 457 plans, employer-sponsored 403(b) plans, profit-sharing plans, non-qualified deferred
compensation plans and other similar employer-sponsored retirement plans. Retirement Plans do not include individual retirement vehicles, such as traditional and Roth individual retirement accounts, Coverdell education savings accounts, individual
403(b)(7) custodial accounts, Keogh plans, SEPs, SARSEPs, SIMPLE IRAs or similar accounts.
Retirement Plans with omnibus accounts held
on the books of the fund can generally invest in Class A, Class C, Class FI, Class R, Class I and Class IS shares.
Investors who rollover fund shares from a Retirement Plan into an individual retirement account administered on the same retirement plan platform may hold, purchase and exchange shares of the fund
to the same extent as the applicable Retirement Plan.
Although Retirement Plans with omnibus accounts held on the books of the fund are
not subject to minimum initial investment requirements for any of these share classes, certain investment minimums may be imposed by a financial intermediary. The distributor may impose certain additional requirements. Please contact your Service
Agent for more information.
Other Retirement Plans
Other Retirement Plans include Retirement Plans investing through brokerage accounts and also include certain Retirement Plans with direct relationships to the fund that are neither
Institutional Investors nor investing through omnibus accounts. Other Retirement Plans and individual retirement vehicles, such as IRAs, are treated like individual investors for purposes of determining sales charges and any applicable sales charge
reductions or waivers.
Other Retirement Plans do not include arrangements whereby an investor would rollover fund shares
from a Retirement Plan into an individual retirement account administered on the same retirement plan platform. Such arrangements are deemed to be Retirement Plans and are subject to the rights and privileges described under
Retirement and Institutional Investors eligible investors Retirement Plans.
Other Retirement Plan investors
can generally invest in Class A, Class C and Class I shares. Individual retirement vehicles may also choose between these share classes.
Clients of Eligible Financial Intermediaries
Clients of Eligible Financial
Intermediaries are investors who invest in the fund through financial intermediaries that (i) charge such investors an ongoing fee for advisory, investment, consulting or similar services, or (ii) have entered into an agreement with
the distributor to offer Class A, Class FI, Class R or Class I shares through a no-load network or platform (Eligible Investment Programs). Such investors may include pension and profit sharing plans, other employee benefit trusts,
endowments, foundations and corporations. Eligible Investment Programs may also include college savings vehicles such as Section 529 plans and direct retail investment platforms through mutual fund supermarkets, where the sponsor
links its clients account (including IRA accounts on such platforms) to a master account in the sponsors name. The financial intermediary may impose separate investment minimums.
Clients of Eligible Financial Intermediaries may invest in Class A, Class FI, Class R or Class I shares. Class I shares are available for exchange from Class A or Class C shares of the
fund by participants in Eligible Investment Programs.
Institutional Investors
Institutional Investors may include corporations, banks, trust companies, insurance companies, investment companies, foundations, endowments, defined benefit plans and other similar
entities. The distributor or the financial intermediary may impose additional eligibility requirements or criteria to determine if an investor, including the types of investors listed above, qualifies as an Institutional Investor.
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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Institutional Investors may invest in Class I or Class IS shares if they meet the $1,000,000
minimum initial investment requirement. Institutional Investors may also invest in Class A and Class C shares, which have different investment minimums, fees and expenses.
Class A shares Retirement Plans
Retirement Plans may buy
Class A Shares. Under certain programs for current and prospective Retirement Plan investors sponsored by financial intermediaries, the initial sales charge and contingent deferred sales charge for Class A shares are waived where:
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Such Retirement Plans record keeper offers only load-waived shares,
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Fund shares are held on the books of the fund through an omnibus account, and
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The Retirement Plan has more than 100 participants or has total assets exceeding $1 million.
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LMIS does not pay Service Agents selling Class A shares to Retirement Plans with a direct omnibus relationship with the fund a commission on
the purchase price of Class A shares sold by them. However, for certain Retirement Plans that are permitted to purchase shares at net asset value, LMIS may pay Service Agents commissions of up to 1.00% of the purchase price of the Class A
shares that are purchased with regular ongoing plan contributions. Please contact your Service Agent for more information.
Class C
shares Retirement Plans
Retirement Plans with omnibus accounts held on the books of the fund may buy Class C shares at
net asset value without paying a contingent deferred sales charge. LMIS does not pay Service Agents selling Class C shares to Retirement Plans with omnibus accounts held on the books of the fund a commission on the purchase price of
Class C shares sold by them. Instead, immediately after purchase, LMIS may pay these Service Agents an annual distribution and/or service fee of up to 1.00% of the average daily net assets represented by the Class C shares serviced by
them.
Certain Retirement Plan programs with exchange features in effect prior to November 20, 2006, as approved by LMIS, will be
eligible for exchange from Class C shares to Class A shares in accordance with the program terms. Please see the SAI for more details.
Class FI shares
Class FI shares are offered only to Clients of Eligible
Financial Intermediaries and Retirement Plan programs.
Class R shares
Class R shares are offered only to eligible Retirement Plans with omnibus accounts held on the books of the fund (either at the plan level or at the level of the financial intermediary), to
Clients of Eligible Financial Intermediaries and through Eligible Investment Programs.
Class I shares
Class I shares are offered only to Institutional Investors and individual investors (investing directly with the fund) who meet the $1,000,000
minimum initial investment requirement, Retirement Plans with omnibus accounts held on the books of the fund and certain rollover IRAs, Clients of Eligible Financial Intermediaries and other investors authorized by LMIS. Certain waivers of these
requirements for individuals associated with the fund, Legg Mason or its affiliates are discussed in the SAI.
Class IS shares
Class IS shares may be purchased only by Retirement Plans with omnibus accounts held on the books of the fund, certain rollover
IRAs and Institutional Investors, and other investors authorized by LMIS. In order to purchase Class IS shares, an investor must hold its shares in one account with the fund, which account is not subject to payment of recordkeeping or similar
fees by the fund to any intermediary.
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Retirement and Institutional Investors eligible investors contd
Other considerations
Plan sponsors, plan fiduciaries and other financial intermediaries may choose to impose qualification requirements that differ from the funds
share class eligibility standards. In certain cases this could result in the selection of a share class with higher distribution and/or service fees than otherwise would have been charged. The fund is not responsible for, and have no control over,
the decision of any plan sponsor, plan fiduciary or financial intermediary to impose such differing requirements. Please consult with your plan sponsor, plan fiduciary or financial intermediary for more information about available share classes.
Your Service Agent may not offer all share classes. Please contact your Service Agent for additional details.
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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Buying shares
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Generally
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You may buy shares at their net asset value next determined after receipt by your Service
Agent or the transfer agent of your purchase request in good order, plus any applicable sales charge.
You must provide the following information for your order to be processed:
Name of fund being
bought
Class of shares being bought
Dollar amount or number
of shares being bought
Account number (if existing account)
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Through a
Service Agent
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You should contact your Service Agent to open a brokerage account and make arrangements to
buy shares.
Your Service Agent may charge an annual account
maintenance fee.
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Through the fund
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Investors should contact the fund at 1-877-721-1926 to open an account and make
arrangements to buy shares.
For initial purchases, complete and send
your account application to the fund at the following address:
Legg Mason Funds
P.O. Box
55214
Boston, Massachusetts 02205-8504
Subsequent purchases should be sent to the same address. Enclose a check to pay for the shares.
For more information, please call the fund between 8:00 a.m. and 5:30 p.m. (Eastern time).
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Through a systematic investment plan
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You may authorize your Service Agent or the transfer agent to transfer funds automatically from (i) a regular bank account, (ii)
cash held in a brokerage account with a Service Agent or (iii) certain money market funds, in order to buy shares on a regular basis.
Amounts transferred must
meet the applicable minimums (see Purchase and sale of fund shares)
Amounts may be transferred monthly, every alternate month, quarterly, semi-annually or
annually
If you do not have sufficient funds in your account on a transfer date, you may be charged a fee
For more information, please contact your Service Agent or the fund or
consult the SAI.
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Exchanging shares
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Generally
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You may exchange shares of the fund for the same class of shares of other funds sold by
the distributor on any day that both the fund and the fund into which you are exchanging are open for business. For investors who qualify as Clients of Eligible Financial Intermediaries and participate in Eligible Investment Programs made available
through their financial intermediaries (such as investors in fee-based advisory or mutual fund wrap programs), an exchange may be made from Class A or Class C shares to Class I shares of the same fund under certain limited circumstances.
Please refer to the section of this prospectus titled Retirement and Institutional Investors eligible investors or contact your financial intermediary for more information.
An exchange of shares of one fund for shares of another fund is considered a
sale and generally results in a capital gain or loss for federal income tax purposes, unless you are investing through an IRA, 401(k) or other tax-advantaged account. An exchange of shares of one class directly for shares of another class of the
same fund normally should not be taxable for federal income tax purposes. You should talk to your tax advisor before making an exchange.
The exchange privilege is not intended as a vehicle for short-term trading. The fund may suspend or terminate your exchange privilege if you engage
in a pattern of excessive exchanges.
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Legg Mason offers a distinctive family of funds tailored to help meet the varying needs of large and small
investors
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You may exchange shares at their net asset value next determined after receipt by your
Service Agent or the transfer agent of your exchange request in good order.
If you bought shares through a Service Agent, contact your Service Agent to learn which funds your
Service Agent makes available to you for exchanges
If you bought shares directly from the fund, call the fund at 1-877-721-1926 to learn which funds
are available to you for exchanges
Exchanges may be made only between accounts that have identical registrations
Not all funds offer all classes
Some funds are offered
only in a limited number of states. Your Service Agent or the fund will provide information about the funds offered in your state
Always be sure to read the prospectus of the fund into which you are exchanging shares.
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Investment minimums, sales charges and other requirements
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In most instances, your shares will not be subject to an initial sales charge or a contingent deferred sales charge at the time of the exchange. You may be charged an
initial or contingent deferred sales charge if the shares being exchanged were not subject to a sales charge.
Except as noted above,
your contingent deferred sales charge (if any) will continue to be measured from the date of your original purchase of shares subject to a contingent deferred sales charge, and you will be subject to the contingent deferred sales charge of the fund
that you originally purchased
You will generally be
required to meet the minimum investment requirement for the class of shares of the fund or share class into which your exchange is made (except in the case of systematic exchange plans)
Your exchange will also be subject to any other requirements of the fund or share class into which you are exchanging shares
The fund may suspend or terminate your exchange privilege if you engage in a pattern of excessive exchanges
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By telephone
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Contact your Service Agent or, if you hold shares directly with the fund, call the fund at 1-877-721-1926 at between 8:00 a.m. and 5:30 p.m. (Eastern time) for information.
Exchanges are priced at the net asset value next determined.
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By mail
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Contact your Service Agent or, if you hold shares directly with the fund, write to the
fund at the following address:
Legg Mason Funds
P.O. Box 55214
Boston,
Massachusetts 02205-8504
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Through a systematic exchange plan
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You may be permitted to schedule automatic exchanges of shares of the fund for shares of other funds available for exchange. All
requirements for exchanging shares described above apply to these exchanges. In addition:
Exchanges may be made
monthly, every alternate month, quarterly, semi-annually or annually
Each exchange must meet the applicable investment minimums for systematic investment plans (see
Purchase and sale of fund shares)
For more
information, please contact your Service Agent or the fund or consult the SAI.
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Redeeming shares
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Generally
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You may redeem shares at their net asset value next determined after receipt by your
Service Agent or the transfer agent of your redemption request in good order, less any applicable contingent deferred sales charge.
If the shares are held by a fiduciary or corporation, partnership or similar entity, other documents may be required.
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Redemption proceeds
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Your redemption proceeds normally will be sent within 3 business days after your request
is received in good order, but in any event within 7 days, except that your proceeds may be delayed for up to 10 days if your share purchase was made by check.
Your redemption proceeds may be delayed, or your right to receive redemption proceeds suspended, if the New York Stock Exchange (NYSE)
is closed (other than on weekends or holidays) or trading is restricted, if an emergency exists or otherwise as permitted by order of the SEC.
If you have a brokerage account with a Service Agent, your redemption proceeds will be sent to your Service Agent. Your redemption proceeds can be
sent by check to your address of record or by wire or electronic transfer (ACH) to a bank account designated by you. To change the bank account designated to receive wire or electronic transfers, you will be required to deliver a new written
authorization and may be asked to provide other documents. You may be charged a fee on a wire or an electronic transfer (ACH).
In other cases, unless you direct otherwise, your proceeds will be paid by check mailed to your address of record.
The fund reserves the right to pay redemption proceeds by giving you
securities. You may pay transaction costs to dispose of those securities, and you may receive less for them than the prices at which they were valued for purposes of the redemption.
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By mail
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Contact your Service Agent or, if you hold shares directly with the fund, write to the
fund at the following address:
Legg Mason Funds
P.O. Box 55214
Boston,
Massachusetts 02205-8504
Your written request must
provide the following:
The fund name, the class of shares being redeemed and your account number
The dollar amount or
number of shares being redeemed
Signature of each owner exactly as the account is registered
Signature guarantees, as applicable (see Other things to know about transactions)
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By telephone
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If your account application permits, you may be eligible to redeem shares by telephone. Contact your Service Agent or, if you hold
shares directly with the fund, call the fund at 1-877-721-1926 between 8:00 a.m. and 5:30 p.m. (Eastern time) for more information. Please have the following information ready when you call:
Name of fund being redeemed
Class of shares being
redeemed
Account number
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Automatic cash withdrawal plans
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You may be permitted to schedule automatic redemptions of a portion of your shares. To qualify, you must own shares of the fund
with a value of at least $10,000 ($5,000 for Retirement Plan accounts) and each automatic redemption must be at least $50.
The following conditions apply:
Redemptions may be made monthly, every alternate month, quarterly, semi-annually or
annually
If your shares are subject to a contingent deferred sales charge, the charge will be required to be paid upon redemption. However, the charge will be waived if your
automatic redemptions are equal to or less than 2% per month of your account balance on the date the redemptions commence, up to a maximum of 12% in one year
You must elect to have
all dividends and distributions reinvested
For more information,
please contact your Service Agent or the fund or consult the SAI.
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Other things to know about transactions
When you buy, exchange or redeem shares, your request must be in good
order. This means you have provided the following information, without which your request may not be processed:
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In the case of a purchase (including a purchase as part of an exchange transaction), the class of shares being bought
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In the case of an exchange or redemption, the class of shares being exchanged or redeemed (if you own more than one class)
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Dollar amount or number of shares being bought, exchanged or redeemed
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In certain circumstances, the signature of each owner exactly as the account is registered (see Redeeming shares)
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The fund generally will not permit non-resident aliens with non-U.S. addresses to establish accounts. U.S. citizens
with APO/FPO addresses or addresses in the United States (including its territories) and resident aliens with U.S. addresses are permitted to establish an account with the fund. Subject to the requirements of local law, U.S. citizens residing in
foreign countries are permitted to establish accounts with the fund.
In certain circumstances, such as during periods of market
volatility, severe weather and emergencies, shareholders may experience difficulties placing exchange or redemption orders by telephone. In that case, shareholders should consider using the funds other exchange and redemption procedures
described above under Exchanging shares and Redeeming shares.
The transfer agent or the fund will employ
reasonable procedures to confirm that any telephone exchange or redemption request is genuine, which may include recording calls, asking the caller to provide certain personal identification information, sending you a written confirmation or
requiring other confirmation procedures from time to time. If these procedures are followed, neither the fund nor its agents will bear any liability for these transactions.
The fund has the right to:
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Suspend the offering of shares
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Waive or change minimum initial and additional investment amounts
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Reject any purchase or exchange order
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Change, revoke or suspend the exchange privilege
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Suspend telephone transactions
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Suspend or postpone redemptions of shares on any day when trading on the NYSE is restricted or as otherwise permitted by the SEC
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Close your account after a period of inactivity, as determined by state law, and transfer your shares to the appropriate state
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Signature guarantees
To be in good order, your redemption request must include a signature guarantee if you:
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Are redeeming shares with the proceeds going to an address or bank not currently on file
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Changed your account registration or your address within 30 days
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Want the check paid to someone other than the account owner(s)
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Are transferring the redemption proceeds to an account with a different registration
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You can obtain a signature guarantee from most banks, dealers, brokers, credit unions and federal savings and loan institutions, but not from a
notary public.
Anti-money laundering
Federal anti-money laundering regulations require all financial institutions to obtain, verify and record information that identifies each person who opens an account. When you sign your account
application,
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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you may be asked to provide additional information in order for the fund to verify your identity in accordance with these regulations. Accounts may be restricted and/or closed, and the monies
withheld, pending verification of this information or as otherwise required under these and other federal regulations.
Small account
fees/Mandatory redemptions
Small accounts may be subject to a small account fee or to mandatory redemption, as described below,
depending on whether the account is held directly with the fund or through a Service Agent.
Direct accounts
Direct accounts generally include accounts held in the name of the individual investor on the funds books and records. To offset the
relatively higher impact on fund expenses of servicing smaller direct accounts, if your shares are held in a direct account and the value of your account is below $1,000 (if applicable, $250 for retirement plans that are not employer-sponsored) for
any reason (including declines in net asset value), the fund may charge you a fee of $3.75 per account that is determined and assessed quarterly on the last business day of the quarter (with an annual maximum of $15.00 per account). The small
account fee will be charged by redeeming shares in your account. If the value of your account is $3.75 or less, the amount in the account may be exhausted to pay the small account fee. The small account fee will not be assessed on systematic
investment plans until the end of the first quarter after the plan has been open for 15 months. The small account fee, including a share redemption, also may result in tax consequences to you (see Taxes for more information).
The small account fee will not be charged on, if applicable: (i) Retirement Plans (but will be charged on other plans that are not
employer-sponsored such as traditional and Roth individual retirement accounts, Coverdell education savings accounts, individual 403(b)(7) custodial accounts, Keogh plans, SEPs, SARSEPs, SIMPLE IRAs or similar accounts); (ii) Legg Mason funds
that have been closed to subsequent purchases for all classes; (iii) accounts that do not have a valid address as evidenced by mail being returned to the fund or its agents; and (iv) Class FI, Class R, Class I and Class IS shares.
If your share class is no longer offered, you may not be able to bring your account up to the minimum investment amount (although you
may exchange into existing accounts at other Legg Mason funds in which you hold the same share class, to the extent otherwise permitted by those funds and subject to any applicable sales charges).
Some shareholders who hold accounts in Classes A and B of the same fund may have those accounts aggregated for the purposes of these calculations.
Please contact the fund or your Service Agent for more information.
Non-direct accounts
Non-direct accounts include omnibus accounts and accounts jointly maintained by the Service Agent and the fund. Such accounts are not
subject to the small account fee that may be charged to direct accounts.
The fund reserves the right to ask you to bring your non-direct
account up to a minimum investment amount determined by your Service Agent if the aggregate value of the fund shares in your account is less than $500 for any reason (including solely due to declines in net asset value and/or failure to invest at
least $500 within a reasonable period). You will be notified in writing and will have 60 days to make an additional investment to bring your account value up to the required level. If you choose not to do so within this 60-day period, the fund may
close your account and send you the redemption proceeds. If your share class is no longer offered, you may not be able to bring your account up to the minimum investment amount. Some shareholders who hold accounts in multiple classes of the same
fund may have those accounts aggregated for the purposes of these calculations. If your account is closed, you will not be eligible to have your account reinstated without imposition of any sales charges that may apply to your new purchase. Please
contact your Service Agent for more information. Any redemption of fund shares may result in tax consequences to you (see Taxes for more information).
All accounts
The fund may, with prior notice, change the minimum size of
accounts subject to mandatory redemption, which may vary by class, implement fees for small non-direct accounts or change the amount of the fee for small direct accounts.
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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Other things to know about transactions contd
Subject to applicable law, the fund may, with prior notice, adopt other
policies from time to time requiring mandatory redemption of shares in certain circumstances.
For more information, please contact
your Service Agent or the fund or consult the SAI.
Frequent trading of fund shares
Frequent purchases and redemptions of fund shares may interfere with the efficient management of the fund, increase fund transaction costs, and have
a negative effect on the funds long-term shareholders. For example, in order to handle large flows of cash into and out of the fund, the subadviser may need to allocate more assets to cash or other short-term investments or sell securities,
rather than maintaining full investment in securities selected to achieve the funds investment objective. Frequent trading may cause the fund to sell securities at less favorable prices. Transaction costs, such as brokerage commissions and
market spreads, can detract from the funds performance. In addition, the return received by long-term shareholders may be reduced when trades by other shareholders are made in an effort to take advantage of certain pricing discrepancies, when,
for example, it is believed that the funds share price, which is determined at the close of the NYSE on each trading day, does not accurately reflect the value of the funds investments. Funds investing in foreign securities have been
particularly susceptible to this form of arbitrage, but other funds could also be affected.
Because of the potential harm to funds sold
by the funds distributor and their long-term shareholders, the Board has approved policies and procedures that are intended to detect and discourage excessive trading and market timing abuses through the use of various surveillance techniques.
Under these policies and procedures, the fund may limit additional exchanges or purchases of fund shares by shareholders who are believed by the manager to be engaged in these abusive trading activities in the fund or in other funds sold by the
distributor. In the event that an exchange or purchase request is rejected, the shareholder may nonetheless redeem its shares. The intent of the policies and procedures is not to inhibit legitimate strategies, such as asset allocation, dollar cost
averaging, or similar activities that may nonetheless result in frequent trading of fund shares.
Under the funds policies and
procedures, the fund reserves the right to restrict or reject purchases of shares (including exchanges) without prior notice whenever a pattern of excessive trading by a shareholder is detected in funds sold by the distributor. A committee
established by the manager administers the policy. The policy provides that the committee may take action, which may include using its best efforts to restrict a shareholders trading privileges in funds sold by the distributor, if that
shareholder has engaged in one or more Round Trips across all funds sold by the distributor. However, the committee has the discretion to determine that action is not necessary if it is determined that the pattern of trading is not
abusive or harmful. In making such a determination, the committee will consider, among other things, the nature of the shareholders account, the reason for the frequent trading, the amount of trading and the particular funds in which the
trading has occurred. Additionally, the committee has the discretion to make inquiries or to take any action against a shareholder whose trading appears inconsistent with the frequent trading policy, regardless of the number of Round Trips. Examples
of the types of actions the committee may take include heightened surveillance of a shareholder account, providing a written warning letter to an account holder, restricting the shareholder from purchasing additional shares in the fund altogether or
imposing other restrictions (such as requiring purchase orders to be submitted by mail) that would deter the shareholder from trading frequently in the fund. The committee will generally follow a system of progressive deterrence, although it is not
required to do so.
A Round Trip is defined as a purchase (including subscriptions and exchanges) into a fund sold by the
distributor followed by a sale (including redemptions and exchanges) of the same or a similar number of shares out of that fund within 30 days of such purchase. Purchases and sales of the funds shares pursuant to an automatic investment plan
or similar program for periodic transactions are not considered in determining Round Trips. These policies and procedures do not apply to money market funds sold by the distributor.
The policies apply to any account, whether a direct account or accounts with financial intermediaries such as investment advisers, broker/dealers or retirement plan administrators, commonly called
omnibus accounts, where the intermediary holds fund shares for a number of its customers in one account. The
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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funds ability to monitor trading in omnibus accounts may, however, be severely limited due to the lack of access to an individual investors trading activity when orders are placed
through these types of accounts. There may also be operational and technological limitations on the ability of the funds service providers to identify or terminate frequent trading activity within the various types of omnibus accounts. The
distributor has entered into agreements with intermediaries requiring the intermediaries to, among other things, help identify frequent trading activity and prohibit further purchases or exchanges by a shareholder identified as having engaged in
frequent trading.
The fund has also adopted policies and procedures to prevent the selective release of information about the
funds holdings, as such information may be used for market-timing and similar abusive practices.
The policies provide for ongoing
assessment of the effectiveness of current policies and surveillance tools, and the Board reserves the right to modify these or adopt additional policies and restrictions in the future. Shareholders should be aware, however, that any surveillance
techniques currently employed by the fund or other techniques that may be adopted in the future may not be effective, particularly where the trading takes place through certain types of omnibus accounts. Furthermore, the fund may not apply its
policies consistently or uniformly, resulting in the risk that some shareholders may be able to engage in frequent trading while others will bear the costs and effects of that trading.
Although the fund will attempt to monitor shareholder transactions for certain patterns of frequent trading activity, there can be no assurance that all such trading activity can be identified,
prevented or terminated. Monitoring of shareholder transactions may only occur for shareholder transactions that exceed a certain transaction amount threshold, which may change from time to time. The fund reserves the right to refuse any client or
reject any purchase order for shares (including exchanges) for any reason.
Record ownership
If you hold shares through a Service Agent, your Service Agent may establish and maintain your account and be the shareholder of record. In the
event that the fund holds a shareholder meeting, your Service Agent, as record holder, will vote your shares in accordance with your instructions. If you do not give your Service Agent voting instructions, your Service Agent, under certain
circumstances, may nonetheless be entitled to vote your shares.
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Dividends, distributions and taxes
Dividends and distributions
The fund generally pays dividends quarterly and makes capital gain distributions, if any, typically once or twice a year. The fund may pay
additional distributions and dividends at other times if necessary for the fund to avoid a federal tax. Unless otherwise directed, capital gain distributions and dividends are reinvested in additional fund shares of the same class of the fund you
hold. You do not pay a sales charge on reinvested distributions or dividends. Alternatively, you can instruct your Service Agent or the fund to have your distributions and/or dividends paid in cash. You can change your choice at any time to be
effective as of the next distribution or dividend.
If you own Class A or Class C shares and hold your shares directly with the
fund, you may instruct the fund to have your distributions and/or dividends invested in Class A or Class C shares, respectively, of another fund sold by the distributor, subject to the following conditions:
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You have a minimum account balance of $10,000
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The fund is available for sale in your state
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To change your election to reinvest your dividends and distributions in shares of another fund, you must notify the fund at least three days before the next distribution is to be paid.
Please contact your Service Agent or the fund to discuss what options are available to you for receiving your dividends and distributions.
Taxes
The following
discussion is very general and does not address investors subject to special rules, such as investors who hold shares in the fund through an IRA, 401(k) or other tax-advantaged account. Because each shareholders circumstances are different and
special tax rules may apply, you should consult your tax adviser about your investment in the fund.
In general, you will have to pay
federal income taxes, as well as any state and local taxes, when you redeem shares, exchange shares or receive a distribution (whether paid in cash or reinvested in additional shares). An exchange between classes of shares of the same fund normally
is not taxable for federal income tax purposes.
The federal income tax treatment of redemptions, exchanges and distributions is
summarized in the following table:
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Transaction
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Federal income tax status
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Redemption or exchange of shares
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Usually capital gain or loss; long-term only if shares owned more than one year
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Long-term capital gain distributions
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Long-term capital gain
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Dividends
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Ordinary income, potentially taxable for individuals at long-term capital gain rates
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Distributions attributable to short-term capital gains are treated as dividends, taxable as ordinary income. Taxable
dividends and long-term capital gain distributions are taxable whether received in cash or reinvested in additional fund shares. Although dividends (including dividends from short-term capital gains) are generally taxable as ordinary income for
taxable years beginning before 2013, unless extended by statute, individual shareholders who satisfy certain holding period and other requirements are taxed on such dividends at long-term capital gain rates to the extent the dividends are
attributable to qualified dividend income received by the fund if the fund satisfies the holding period and other requirements as well. Qualified dividend income generally consists of dividends from U.S. corporations (other
than certain dividends from REITs) and certain foreign corporations. Some regulated investment companies such as the fund and many ETFs may pass through to the fund qualified dividend income received from investments.
Long-term capital gain distributions are taxable to you as long-term capital gain regardless of how long you have owned your shares. You may want to
avoid buying shares when the fund is about to declare a capital gain distribution or a dividend, because it will be taxable to you even though it may effectively be a return of a portion of your investment. You may receive taxable gains from
transactions by the fund.
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Beginning in 2013, a 3.8 percent Medicare contribution tax will be imposed on net investment income,
including interest, dividends, and capital gain, of U.S. individuals with income exceeding $200,000 (or $250,000 if married filing jointly), and of estates and trusts.
The Internal Revenue Code will impose a U.S. withholding tax of 30% on payments (including gross proceeds) that are attributable to certain U.S. investments and made to a non-U.S. financial
institution, including a non-U.S. investment fund. The fund will withhold at this rate on certain of its distributions and redemptions unless any non-U.S. financial institution shareholder complies with certain reporting requirements to the Internal
Revenue Service in respect of its direct and indirect U.S. investors effective beginning with payments of dividends made after December 31, 2013 and payments of gross proceeds made after December 31, 2014. Non-U.S. financial institution
shareholders should consult their own tax advisers regarding the possible implications of these requirements on their investment in the fund.
Distributions derived from interest on U.S. government securities (but not distributions of gain from the sale of such securities) may be exempt from state and local taxes. A dividend declared by
the fund in October, November or December and paid during January of the following year will, in certain circumstances, be treated as paid in December for tax purposes.
The fund may be subject to non-U.S. income taxes withheld at the source. The fund, if permitted to do so, may elect to pass through to its investors the amount of non-U.S. income taxes
paid by the fund provided that the fund meets certain holding requirements for the security. As a result, provided an investor meets holding period requirements with respect to shares of the fund, the shareholder will (i) include in gross
income, even though not actually received, the investors pro rata share of the funds non-U.S. income taxes, and (ii) either deduct or credit the investors pro rata share of the funds non-U.S. income taxes. A non-U.S.
person invested in the fund in a year that the fund elects to pass through its non-U.S. taxes may be treated as receiving additional dividend income subject to U.S. withholding tax. Certain limitations will be imposed to the extent to
which the non-U.S. tax credit may be claimed.
After the end of the year, your Service Agent or the fund will provide you with
information about the distributions and dividends you received and any redemptions of shares during the previous year. If you do not provide your fund with your correct taxpayer identification number and any required certifications, you may be
subject to backup withholding on your distributions, dividends, and redemption proceeds.
The above discussion is applicable to
shareholders who are U.S. persons. If you are a non-U.S. person, please consult your own tax adviser with respect to the U.S. tax consequences to you of an investment in the fund.
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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Share price
You may buy, exchange or redeem shares at their net asset value next determined after receipt of your request in good
order, adjusted for any applicable sales charge. The funds net asset value per share is the value of its assets minus its liabilities divided by the number of shares outstanding. Net asset value is calculated separately for each class of
shares.
The fund calculates its net asset value every day the NYSE is open. The fund generally values its securities and other assets
and calculates its net asset value as of the close of regular trading on the NYSE, normally at 4:00 p.m. (Eastern time). If the NYSE closes at another time, the fund will calculate its net asset value as of the actual closing time. The NYSE is
closed on certain holidays listed in the SAI.
In order to buy, redeem or exchange shares at a certain days price, you must place
your order with your Service Agent or the transfer agent before the NYSE closes on that day. If the NYSE closes early on that day, you must place your order prior to the actual closing time. It is the responsibility of the Service Agent to transmit
all orders to buy, exchange or redeem shares to the transfer agent on a timely basis.
Valuation of the funds securities and other
assets is performed in accordance with procedures approved by the Board. These procedures delegate most valuation functions to the manager, which, in turn, uses independent third party pricing services approved by the funds Board. Under the
procedures, assets are valued as follows:
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Equity securities and certain derivative instruments that are traded on an exchange are valued at the closing price or, if that price is
unavailable or deemed by the manager not representative of market value, the last sale price. Where a security is traded on more than one exchange (as is often the case overseas), the security is generally valued at the price on the exchange
considered by the manager to be the primary exchange. In the case of securities not traded on an exchange, or if exchange prices are not otherwise available, the prices are typically determined by independent third party pricing services that use a
variety of techniques and methodologies.
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The valuations for fixed income securities and certain derivative instruments are typically the prices supplied by independent third party
pricing services, which may use market prices or broker/dealer quotations or a variety of fair valuation techniques and methodologies. Short-term fixed income securities that will mature in 60 days or less are valued at amortized cost, unless it is
determined that using this method would not reflect an investments fair value.
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The valuations of securities traded on foreign markets and certain fixed income securities will generally be based on prices determined as of the
earlier closing time of the markets on which they primarily trade, unless a significant event has occurred. When the fund holds securities or other assets that are denominated in a foreign currency, it will normally use the currency exchange rates
as of 4:00 p.m. (Eastern time). The fund uses a fair value model developed by an independent third party pricing service to value foreign equity securities on days when a certain percentage change in the value of a domestic equity security
index suggests that the closing prices on foreign exchanges may no longer represent the value of those securities at the time of closing of the NYSE. Foreign markets are open for trading on weekends and other days when the fund does not price its
shares. Therefore, the value of the funds shares may change on days when you will not be able to purchase or redeem the funds shares.
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If independent third party pricing services are unable to supply prices for a portfolio investment, or if the prices supplied are deemed by the
manager to be unreliable, the market price may be determined by the manager using quotations from one or more broker/dealers. When such prices or quotations are not available, or when the manager believes that they are unreliable, the manager may
price securities using fair value procedures approved by the Board. These procedures permit, among other things, the use of a matrix, formula or other method that takes into consideration market indices, yield curves and other specific adjustments
to determine fair value. Fair value of a security is the amount, as determined by the manager in good faith, that a fund might reasonably expect to receive upon a current sale of the security. The fund may also use fair value procedures if the
manager determines that a significant event has occurred between the time at which a market price is determined and the time at which the funds net asset value is calculated.
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Many factors may influence the price at which the fund could sell any particular portfolio investment. The sales price may well differhigher
or lowerfrom the funds last valuation, and such differences could be
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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39
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significant, particularly for securities that trade in relatively thin markets and/or markets that experience extreme volatility. Moreover, valuing securities using fair value methodologies
involves greater reliance on judgment than valuing securities based on market quotations. A fund that uses fair value methodologies may value those securities higher or lower than another fund using market quotations or its own fair value
methodologies to price the same securities. There can be no assurance that the fund could obtain the value assigned to a security if it were to sell the security at approximately the time at which the fund determines its net asset value. Investors
who purchase or redeem fund shares on days when the fund is holding fair-valued securities may receive a greater or lesser number of shares, or higher or lower redemption proceeds, than they would have received if the fund had not fair-valued the
security or had used a different methodology.
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Legg Mason Batterymarch Managed Volatility International Dividend Fund
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Financial highlights
As the fund has not commenced operations as of the date of this
Prospectus, no financial information is available.
Legg Mason Funds Privacy and Security Notice
Your Privacy and the Security of Your Personal Information is Very Important to the Legg Mason Funds
This Privacy and Security Notice (the Privacy Notice) addresses the Legg Mason Funds privacy and data protection practices with
respect to nonpublic personal information the Funds receive. The Legg Mason Funds include any funds sold by the Funds distributor, Legg Mason Investor Services, LLC, as well as Legg Mason-sponsored closed-end funds and certain closed-end funds
managed or sub-advised by Legg Mason or its affiliates. The provisions of this Privacy Notice apply to your information both while you are a shareholder and after you are no longer invested with the Funds.
The Type of Nonpublic Personal Information the Funds Collect About You
The Funds collect and maintain nonpublic personal information about you in connection with your shareholder account. Such information may include, but is not limited to:
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Personal information included on applications or other forms;
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Account balances, transactions, and mutual fund holdings and positions;
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Online account access user IDs, passwords, security challenge question responses; and
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Information received from consumer reporting agencies regarding credit history and creditworthiness (such as the amount of an individuals
total debt, payment history, etc.).
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How the Funds Use Nonpublic Personal Information About You
The Funds do not sell or share your nonpublic personal information with third parties or with affiliates for their marketing purposes, or with other
financial institutions or affiliates for joint marketing purposes, unless you have authorized the Funds to do so. The Funds do not disclose any nonpublic personal information about you except as may be required to perform transactions or services
you have authorized or as permitted or required by law. The Funds may disclose information about you to:
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Employees, agents, and affiliates on a need to know basis to enable the Funds to conduct ordinary business or comply with obligations
to government regulators;
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Service providers, including the Funds affiliates, who assist the Funds as part of the ordinary course of business (such as printing,
mailing services, or processing or servicing your account with us) or otherwise perform services on the Funds behalf, including companies that may perform marketing services solely for the Funds;
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The Funds representatives such as legal counsel, accountants and auditors; and
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Fiduciaries or representatives acting on your behalf, such as an IRA custodian or trustee of a grantor trust.
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Except as otherwise permitted by applicable law, companies acting on the Funds behalf are contractually obligated to keep nonpublic personal
information the Funds provide to them confidential and to use the information the Funds share only to provide the services the Funds ask them to perform.
The Funds may disclose nonpublic personal information about you when necessary to enforce their rights or protect against fraud, or as permitted or required by applicable law, such as in connection
with a law enforcement or regulatory request, subpoena, or similar legal process. In the event of a corporate action or in the event a Fund service provider changes, the Funds may be required to disclose your nonpublic personal information to third
parties. While it is the Funds practice to obtain protections for disclosed information in these types of transactions, the Funds cannot guarantee their privacy policy will remain unchanged.
Keeping you Informed of the Funds Privacy and Security Practices
The Funds will notify you annually of their privacy policy as required by federal law. While the Funds reserve the right to modify this policy at any time they will notify you promptly if this
privacy policy changes.
Legg Mason Funds Privacy and Security Notice contd
The Funds Security Practices
The Funds maintain appropriate physical, electronic and procedural safeguards designed to guard your nonpublic personal information. The Funds
internal data security policies restrict access to your nonpublic personal information to authorized employees, who may use your nonpublic personal information for Fund business purposes only.
Although the Funds strive to protect your nonpublic personal information, they cannot ensure or warrant the security of any information you provide
or transmit to them, and you do so at your own risk. In the event of a breach of the confidentiality or security of your nonpublic personal information, the Funds will attempt to notify you as necessary so you can take appropriate protective steps.
If you have consented to the Funds using electronic communications or electronic delivery of statements, they may notify you under such circumstances using the most current email address you have on record with them.
In order for the Funds to provide effective service to you, keeping your account information accurate is very important. If you believe that your
account information is incomplete, not accurate or not current, or if you have questions about the Funds privacy practices, write the Funds using the contact information on your account statements, email the Funds by clicking on the Contact Us
section of the Funds website at www.leggmason.com, or contact the Funds at 1-877-721-1926.
[These pages are not
part of the Prospectus.]
Legg Mason Batterymarch
Managed Volatility International Dividend Fund
You may visit the funds website, http://www.leggmason.com/ individualinvestors/prospectuses, for a free copy of a Prospectus, Statement of Additional Information (SAI) or an Annual
or Semi-Annual Report.
Shareholder reports
Additional information about the funds investments is available in the funds Annual and Semi-Annual Reports to shareholders. In the funds Annual Report, you will find a discussion
of the market conditions and investment strategies that significantly affected the funds performance during its last fiscal year.
The fund sends only one report to a household if more than one account has the same last name and same address. Contact your Service Agent or the
fund if you do not want this policy to apply to you.
Statement of
additional information
The SAI provides more detailed information about the fund and is incorporated by reference into (is legally a part of) this Prospectus.
You can make inquiries about the fund or obtain shareholder reports or the SAI (without charge) by contacting your Service
Agent, by calling the fund at 1-877-721-1926, or by writing to the fund at 100 First Stamford Place, Attn.: Shareholder Services 5
th
Floor, Stamford, Connecticut 06902.
Information about the fund (including the SAI) can be reviewed and copied at the Securities and Exchange Commissions (the SEC) Public Reference Room in Washington, D.C. Information
on the operation of the Public Reference Room may be obtained by calling the SEC at 1-202-551-8090. Reports and other information about the fund are available on the EDGAR Database on the SECs Internet site at
http://www.sec.gov.
Copies of this information may be obtained for a duplicating fee by electronic request at the following
E-mail address:
publicinfo@sec.gov,
or by writing the SECs Public Reference Section, Washington, D.C.
20549-1520.
If someone makes a statement about the fund that is not in this Prospectus, you should not rely upon that information.
Neither the fund nor the distributor are offering to sell shares of the fund to any person to whom the fund may not lawfully sell its shares.
(Investment Company Act
file no. 811-06444)
[ ]ST 02/13
The information in this Statement of Additional Information is not complete and may be
changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This Statement of Additional Information is not an offer to sell these securities and is not soliciting an
offer to buy these securities in any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION,
[ ], 2013
LEGG MASON PARTNERS EQUITY TRUST
Legg Mason Batterymarch Managed Volatility International Dividend Fund
Class A, Class C, Class FI, Class R, Class I and Class IS
55 Water Street
New York, New York 10041
1-877-721-1926
STATEMENT OF ADDITIONAL INFORMATION
This Statement of Additional Information (the SAI) is not a prospectus and is meant to be read in conjunction with the current Prospectus of Legg Mason Batterymarch Managed Volatility
International Dividend Fund (the fund) dated [ ], 2013, as amended or supplemented from time to time, and is incorporated by reference in its entirety into the Prospectus.
The fund is a series of Legg Mason Partners Equity Trust (the Trust), a Maryland statutory trust.
Additional information about the funds investments will be available in the funds annual and semi-annual reports to
shareholders. The funds Prospectus and copies of the annual and semi-annual reports, when available, may be obtained free of charge by contacting banks, brokers, dealers, insurance companies, investment advisers, financial consultants or
advisers, mutual fund supermarkets and other financial intermediaries that have entered into an agreement with the funds distributor to sell shares of the fund (each called a Service Agent), by writing or calling the Trust at the
address or telephone number set forth above, by sending an e-mail request to prospectus@leggmason.com or by visiting the funds website at http://www.leggmason.com/individualinvestors. Legg Mason Investor Services, LLC (LMIS or the
distributor), a wholly-owned broker/dealer subsidiary of Legg Mason, Inc. (Legg Mason), serves as the funds sole and exclusive distributor.
TABLE OF CONTENTS
THIS SAI IS NOT A PROSPECTUS AND IS AUTHORIZED FOR DISTRIBUTION TO PROSPECTIVE INVESTORS ONLY IF
PRECEDED OR ACCOMPANIED BY AN EFFECTIVE PROSPECTUS.
No person has been authorized to give any information or to make any
representations not contained in the Prospectus or this SAI in connection with the offerings made by the Prospectus and, if given or made, such information or representations must not be relied upon as having been authorized by the fund or its
distributor. The Prospectus and this SAI do not constitute offerings by the fund or by the distributor in any jurisdiction in which such offerings may not lawfully be made.
2
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES
The fund is registered under the Investment Company Act of 1940, as amended (the 1940 Act) as an open-end, diversified
management investment company.
The funds Prospectus discusses the funds investment objective and policies. The
following discussion supplements the description of the funds investment policies in its Prospectus.
Investment Objective and
Principal Investment Strategies
The fund seeks to provide long-term capital appreciation and income.
Under normal circumstances, the fund invests at least 80% of its net assets, plus the amount of borrowings for investment purposes, if
any, in equity and equity-related securities that provide investment income, dividend payments or other distributions or in other investments with similar economic characteristics. The fund invests substantially all of its assets in securities of
non-U.S. issuers, including issuers in emerging markets, and may invest in issuers of any market capitalization.
The
subadviser invests only in stocks expected to pay dividends and favors stocks with lower volatility characteristics as identified by its proprietary security risk assessment process.
The subadviser uses a bottom-up approach that assesses stocks based on their individual strengths, rather than focusing on the underlying
sectors/industries of those stocks or on general economic trends. The subadviser pursues the funds investment objective by implementing an investment strategy that utilizes proprietary quantitative investment models to assist with stock
selection, portfolio construction and risk control.
The subadviser seeks to manage volatility through following methods:
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Analyzing outputs from their multifactor risk model and measurements of each stocks risk relative to the overall risk of the equity markets
(beta)
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Looking for companies that offer a combination of attractive yields, high dividend growth, a record of increasing dividends and the cash flow to
support dividend payments
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Both of these types of risk measures (statistical and fundamental) are used to
assist the subadviser in constructing a portfolio of securities for the fund.
Additionally, elements of the subadvisers
multi-dimensional stock-ranking model, primarily cash-flow related factors, are used to identify securities that the subadviser believes will have less volatility than the overall equity markets.
The subadviser evaluates its investment models over time and the factors used in the models may change. The subadviser may take
additional, non-quantitative factors into account when selecting portfolio securities, including the subadvisers macroeconomic outlook.
The funds investment strategies may be changed without shareholder approval. The funds investment objective may be changed by the Board of Trustees (the Board) without shareholder
approval and on notice to shareholders.
There is no guarantee that the fund will achieve its investment objective.
3
INVESTMENT PRACTICES AND RISK FACTORS
The funds principal investment strategies are described above. The following provides additional information about these principal
strategies and describes other investment strategies and practices that may be used by the fund, which all involve risks of varying degrees.
Market Sector Risk.
The fund may be significantly overweight or underweight certain companies, industries or market sectors, which may cause the funds performance to be more sensitive to
developments affecting those companies, industries or sectors.
Equity Securities
General.
Investors should realize that risk of loss is inherent in the ownership of any securities and that the net asset value
(NAV) of the fund will fluctuate, reflecting fluctuations in the market value of its portfolio positions.
Common Stocks.
The fund may purchase common stocks. Common stocks are shares of a corporation or other entity that entitle the
holder to a pro rata share of the profits of the corporation, if any, without preference over any other shareholder or class of shareholders, including holders of the entitys preferred stock and other senior equity. Common stock usually
carries with it the right to vote and frequently an exclusive right to do so. Common stocks include securities issued by limited partnerships, limited liability companies, business trusts and companies organized outside the United States.
Convertible Securities.
The fund may invest in convertible securities. A convertible security is a bond, debenture,
note, preferred stock or other security that may be converted into or exchanged for a prescribed amount of common stock of the same or a different issuer within a particular period of time at a specified price or formula. A convertible security
entitles the holder to receive interest paid or accrued on debt or the dividend paid on preferred stock until the convertible security matures or is redeemed, converted or exchanged. Before conversion or exchange, convertible securities ordinarily
provide a stream of income with generally higher yields than those of common stocks of the same or similar issuers, but lower than the yield of nonconvertible debt. Convertible securities are usually subordinated to comparable-tier nonconvertible
securities but rank senior to common stock in a corporations capital structure.
The value of a convertible security is
a function of (1) its yield in comparison with the yields of other securities of comparable maturity and quality that do not have a conversion privilege and (2) its worth, at market value, if converted or exchanged into the underlying
common stock. A convertible security may be subject to redemption at the option of the issuer at a price established in the convertible securitys governing instrument, which may be less than the ultimate conversion or exchange value.
Convertible securities are subject both to the stock market risk associated with equity securities and to the credit and
interest rate risks associated with fixed income securities. As the market price of the equity security underlying a convertible security falls, the convertible security tends to trade on the basis of its yield and other fixed income
characteristics. As the market price of such equity security rises, the convertible security tends to trade on the basis of its equity conversion features.
Preferred Stock.
The fund may invest in preferred stocks. Preferred stock pays dividends at a specified rate and generally has preference over common stock in the payment of dividends and the
liquidation of the issuers assets, but is junior to the debt securities of the issuer in those same respects. Unlike interest payments on debt securities, dividends on preferred stock are generally payable at the discretion of the
issuers board of directors. Holders of preferred stock may suffer a loss of value if dividends are not paid. The market prices of preferred stocks are subject to changes in interest rates and are more sensitive to changes in the issuers
creditworthiness than are the prices of debt securities. Generally, under normal circumstances, preferred stock does not carry
4
voting rights. Upon liquidation, preferred stocks are entitled to a specified liquidation preference, which is generally the same as the par or stated value, and are senior in right of payment to
common stock. Preferred stocks are, however, equity securities in the sense that they do not represent a liability of the issuer and, therefore, do not offer as great a degree of protection of capital or assurance of continued income as investments
in corporate debt securities. In addition, preferred stocks are subordinated in right of payment to all debt obligations and creditors of the issuer, and convertible preferred stocks may be subordinated to other preferred stock of the same issuer.
Warrants.
The fund may invest in warrants, which provide the fund with the right to purchase other securities of the
issuer at a later date.
Warrants are subject to the same market risks as stocks, but may be more volatile in price. Because
investing in warrants can provide a greater potential for profit or loss than an equivalent investment in the underlying security, warrants involve leverage and are considered speculative investments. At the time of issuance of a warrant, the cost
is generally substantially less than the cost of the underlying security itself, and therefore, the investor is able to gain exposure to the underlying security with a relatively low capital investment. Price movements in the underlying security are
generally magnified in the price movements of the warrant, although changes in the market value of the warrant may not necessarily correlate to the prices of the underlying security. The funds investment in warrants will not entitle it to
receive dividends or exercise voting rights and will become worthless if the warrants cannot be profitably exercised before the expiration dates.
Real Estate Investment Trusts.
The fund may invest in shares of real estate investment trusts (REITs), which are pooled investment vehicles that invest in real estate or real estate
loans or interests. REITs are generally classified as equity REITs, mortgage REITs or a combination of equity and mortgage (hybrid) REITs. Equity REITs invest the majority of their assets directly in real property and derive income primarily from
the collection of rents. Equity REITs can also realize capital gains by selling properties that have appreciated in value. Mortgage REITs invest the majority of their assets in real estate mortgages and derive income from the collection of interest
payments. A mortgage REIT can make construction, development or long-term mortgage loans, which are sensitive to the credit quality of the borrower. Hybrid REITs combine the characteristics of both equity and mortgage trusts, generally by holding
both ownership interests and mortgage interests in real estate. REITs are not taxed on income distributed to shareholders provided they comply with the applicable requirements of the Internal Revenue Code of 1986, as amended (the Code).
Debt securities issued by REITs, for the most part, are general and unsecured obligations and are subject to risks associated with REITs. Like mutual funds, REITs have expenses, including advisory and administration fees paid by REIT shareholders
and, as a result, an investor is subject to a duplicate level of fees if the fund invests in REITs.
Investing in REITs
involves certain unique risks in addition to those risks associated with investing in the real estate industry in general. An equity REIT may be affected by changes in the value of the underlying properties owned by the REIT. A mortgage REIT may be
affected by changes in interest rates and the ability of the issuers of its portfolio mortgages to repay their obligations. REITs are dependent upon the skills of their managers and are not diversified. REITs are generally dependent upon maintaining
cash flows to repay borrowings and to make distributions to shareholders and are subject to the risk of default by lessees and borrowers. REITs whose underlying assets are concentrated in properties used by a particular industry, such as health
care, are also subject to industry related risks.
REITs (especially mortgage REITs) are also subject to interest rate risks.
When interest rates decline, the value of a REITs investment in fixed income obligations can be expected to rise. Conversely, when interest rates rise, the value of a REITs investment in fixed rate obligations can be expected to decline.
If the REIT invests in adjustable rate mortgage loans (the interest rates on which are reset periodically) yields on a REITs investments in such loans will gradually align themselves to reflect changes in market interest rates. This causes the
value of such investments to fluctuate less dramatically in response to interest rate fluctuations than would investments in fixed rate obligations. REITs may have limited financial resources, may trade less frequently and in a limited volume and
may be subject to more abrupt or erratic price movements than larger company securities.
5
The values of securities issued by REITs are affected by tax and regulatory requirements and
by perceptions of management skill. They are also subject to heavy cash flow dependency, defaults by borrowers or tenants, self-liquidation, the possibility of failing to qualify for the ability to avoid tax by satisfying distribution requirements
under the Code, and failing to maintain exemption from the 1940 Act. Also, the fund will indirectly bear its proportionate share of expenses incurred by REITs in which the fund invests. REITs are also sensitive to factors such as changes in real
estate values and property taxes, interest rates, overbuilding and creditworthiness of the issuer.
Investment in Other
Investment Company Securities.
The fund may invest in the securities of other investment companies, which can include open-end funds, closed-end funds and unregistered investment companies, subject to the limits set forth in the 1940 Act that
apply to these types of investments. Investments in other investment companies are subject to the risks of the securities in which those investment companies invest. In addition, to the extent the fund invests in securities of other investment
companies, fund shareholders would indirectly pay a portion of the operating costs of such companies in addition to the expenses of the funds own operation. These costs include management, brokerage, shareholder servicing and other operational
expenses.
The fund may invest in shares of mutual funds or unit investment trusts that are traded on a stock exchange, called
exchange-traded funds (ETFs). Typically, an ETF seeks to track the performance of an index, such as the S&P 500 Index, the NASDAQ-100 Index, the Barclays Capital Treasury Bond Index, or more narrow sector or foreign indexes, by
holding in its portfolio either the same securities that comprise the index, or a representative sample of the index. Investing in an ETF will give the fund exposure to the securities comprising the index on which the ETF is based.
Unlike shares of typical mutual funds or unit investment trusts, shares of ETFs are designed to be traded throughout the trading day,
bought and sold based on market prices rather than NAV. Shares can trade at either a premium or discount to NAV. However, the portfolios held by index-based ETFs are publicly disclosed on each trading day, and an approximation of actual NAV is
disseminated throughout the trading day. Because of this transparency, the trading prices of index-based ETFs tend to closely track the actual NAV of the underlying portfolios and the fund will generally gain or lose value depending on the
performance of the index. However, gains or losses on the funds investment in ETFs will ultimately depend on the purchase and sale price of the ETF. In the future, as new products become available, the fund may invest in ETFs that are actively
managed. Actively managed ETFs will likely not have the transparency of index-based ETFs and, therefore, may be more likely to trade at a larger discount or premium to actual NAVs.
The fund may invest in closed-end funds, which hold securities of U.S. and/or non-U.S. issuers. Because shares of closed-end funds trade
on an exchange, investments in closed-end funds may entail the additional risk that the discount from NAV could increase while the fund holds the shares.
Foreign Securities.
The fund has no geographic limits in where it may
invest. The fund may invest in both developed and emerging markets. The fund may invest directly in foreign issuers or invest in depositary receipts. The returns of the fund may be adversely affected by fluctuations in value of one or more
currencies relative to the U.S. dollar. Investing in the securities of foreign companies involves special risks and considerations not typically associated with investing in U.S. companies. These include risks resulting from revaluation of
currencies; future adverse political and economic developments; possible imposition of currency exchange blockages or other foreign governmental laws or restrictions; reduced availability of public information concerning issuers; differences in
accounting, auditing and financial reporting standards; generally higher commission rates on foreign portfolio transactions; possible expropriation, nationalization or confiscatory taxation; possible withholding taxes and limitations on the use or
removal of funds or other assets, including the withholding of dividends; adverse changes in investment or exchange control regulations; political instability, which could affect U.S. investments in foreign countries; and potential restrictions on
the flow of international capital. Additionally, foreign securities
6
often trade with less frequency and volume than domestic securities and, therefore, may exhibit greater price volatility and be less liquid. Foreign securities may not be registered with, nor the
issuers thereof be subject to the reporting requirements of, the Securities and Exchange Commission (the SEC). Accordingly, there may be less publicly available information about the securities and about the foreign company issuing them
than is available about a U.S. company and its securities. Moreover, individual foreign economies may differ favorably or unfavorably from the U.S. economy in such respects as growth of gross domestic product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payment positions. These risks are intensified when investing in countries with developing economies and securities markets, also known as emerging markets.
The costs associated with investment in the securities of foreign issuers, including withholding taxes, brokerage commissions and
custodial fees, may be higher than those associated with investment in domestic issuers. In addition, foreign investment transactions may be subject to difficulties associated with the settlement of such transactions. Transactions in securities of
foreign issuers may be subject to less efficient settlement practices, including extended clearance and settlement periods. Delays in settlement could result in temporary periods when assets of the fund are uninvested and no return can be earned on
them. The inability of the fund to make intended investments due to settlement problems could cause the fund to miss attractive investment opportunities. The inability to dispose of a portfolio security due to settlement problems could result in
losses to the fund due to subsequent declines in value of the portfolio security or, if the fund has entered into a contract to sell the security, could result in liability to the purchaser.
Since the fund may invest in securities denominated in currencies other than the U.S. dollar, it may be affected favorably or unfavorably
by exchange control regulations or changes in the exchange rates between such currencies and the U.S. dollar. Changes in currency exchange rates may influence the value of the funds shares and may also affect the value of dividends and
interest earned by the fund and gains and losses realized by the fund. Exchange rates are determined by the forces of supply and demand in the foreign exchange markets. These forces are affected by the international balance of payments, other
economic and financial conditions, government intervention, speculation and other factors.
Economic, Political and Social
Factors.
Certain non-U.S. countries, including emerging markets, may be subject to a greater degree of economic, political and social instability. Such instability may result from, among other things: (i) authoritarian governments or
military involvement in political and economic decision making; (ii) popular unrest associated with demands for improved economic, political and social conditions; (iii) internal insurgencies; (iv) hostile relations with neighboring
countries; and (v) ethnic, religious and racial disaffection and conflict. Such economic, political and social instability could significantly disrupt the financial markets in such countries and the ability of the issuers in such countries to
repay their obligations. In addition, it may be difficult for the fund to pursue claims against a foreign issuer in the courts of a foreign country. Investing in emerging countries also involves the risk of expropriation, nationalization,
confiscation of assets and property or the imposition of restrictions on foreign investments and on repatriation of capital invested. In the event of such expropriation, nationalization or other confiscation in any emerging country, the fund could
lose its entire investment in that country. Certain emerging market countries restrict or control foreign investment in their securities markets to varying degrees. These restrictions may limit the funds investment in those markets and may
increase the expenses of the fund. In addition, the repatriation of both investment income and capital from certain markets in the region is subject to restrictions such as the need for certain governmental consents. Even where there is no outright
restriction on repatriation of capital, the mechanics of repatriation may affect certain aspects of the funds operation. Economies in individual non-U.S. countries may differ favorably or unfavorably from the U.S. economy in such respects as
growth of gross domestic product, rates of inflation, currency valuation, capital reinvestment, resource self-sufficiency and balance of payments positions. Many non-U.S. countries have experienced substantial, and in some cases extremely high,
rates of inflation for many years. Inflation and rapid fluctuations in inflation rates have had, and may continue to have, very negative effects on the economies and securities markets of certain emerging countries. Economies in emerging countries
generally are dependent heavily upon international trade and, accordingly, have been and may continue to be affected adversely by trade barriers, exchange controls, managed adjustments in relative currency values and other
7
protectionist measures imposed or negotiated by the countries with which they trade. These economies also have been, and may continue to be, affected adversely and significantly by economic
conditions in the countries with which they trade. Whether or not the fund invests in securities of issuers located in or with significant exposure to countries experiencing economic, financial and other difficulties, the value and liquidity of the
funds investments may be negatively affected by the conditions in the countries experiencing the difficulties.
EuropeRecent Events.
A number of countries in Europe have experienced severe economic and financial difficulties. Many
non-governmental issuers, and even certain governments, have defaulted on, or been forced to restructure, their debts; many other issuers have faced difficulties obtaining credit or refinancing existing obligations; financial institutions have in
many cases required government or central bank support, have needed to raise capital, and/or have been impaired in their ability to extend credit; and financial markets in Europe and elsewhere have experienced extreme volatility and declines in
asset values and liquidity. These difficulties may continue, worsen or spread within and without Europe. Responses to the financial problems by European governments, central banks and others, including austerity measures and reforms, may not work,
may result in social unrest and may limit future growth and economic recovery or have other unintended consequences. Further defaults or restructurings by governments and others of their debt could have additional adverse effects on economies,
financial markets and asset valuations around the world. In addition, one or more countries may abandon the euro, the common currency of the European Union, and/or withdraw from the European Union. The impact of these actions, especially if they
occur in a disorderly fashion, is not clear but could be significant and far-reaching. Whether or not the fund invests in securities of issuers located in Europe or with significant exposure to European issuers or countries, these events could
negatively affect the value and liquidity of the funds investments.
Restrictions on Foreign Investment.
Some
countries prohibit or impose substantial restrictions on investments in their capital markets, particularly their equity markets, by foreign entities such as the fund. For example, certain countries require governmental approval prior to investments
by foreign persons, limit the amount of investment by foreign persons in a particular company or limit the investment by foreign persons to only a specific class of securities of a company that may have less advantageous terms than securities of the
company available for purchase by nationals or limit the repatriation of funds for a period of time.
In some countries, banks
or other financial institutions may constitute a substantial number of the leading companies or the companies with the most actively traded securities. Also, the 1940 Act restricts the funds investments in any equity security of an issuer
which, in its most recent fiscal year, derived more than 15% of its revenues from securities related activities, as defined by the rules thereunder. These provisions may also restrict the funds investments in certain foreign banks
and other financial institutions.
Smaller capital markets, while often growing in trading volume, have substantially less
volume than U.S. markets, and securities in many smaller capital markets are less liquid and their prices may be more volatile than securities of comparable U.S. companies. Brokerage commissions, custodial services and other costs relating to
investment in smaller capital markets are generally more expensive than in the United States. Such markets have different clearance and settlement procedures, and in certain markets there have been times when settlements have been unable to keep
pace with the volume of securities transactions, making it difficult to conduct such transactions. Further, satisfactory custodial services for investment securities may not be available in some countries having smaller capital markets, which may
result in the fund incurring additional costs and delays in transporting and custodying such securities outside such countries. Delays in settlement could result in temporary periods when assets of the fund are uninvested and no return is earned
thereon. The inability of the fund to make intended security purchases due to settlement problems could cause the fund to miss attractive investment opportunities. Inability to dispose of a portfolio security due to settlement problems could result
either in losses to the fund due to subsequent declines in value of the portfolio security or, if the fund has entered into a contract to sell the security, could result in possible liability to the purchaser. Generally, there is less government
supervision and regulation of exchanges, brokers and issuers in countries having smaller capital markets than there is in the United States.
8
Depositary Receipts.
Generally, American Depositary Receipts (ADRs), in
registered form, are denominated in U.S. dollars and are designed for use in the domestic market. Usually issued by a U.S. bank or trust company, ADRs are receipts that demonstrate ownership of underlying foreign securities. For purposes of the
funds investment policies and limitations, ADRs are considered to have the same characteristics as the securities underlying them. ADRs may be sponsored or unsponsored; issuers of securities underlying unsponsored ADRs are not contractually
obligated to disclose material information in the United States.
Accordingly, there may be less information available about
such issuers than there is with respect to domestic companies and issuers of securities underlying sponsored ADRs. The fund may also invest in Global Depositary Receipts (GDRs), European Depositary Receipts (EDRs) and other
similar instruments, which are receipts that are often denominated in U.S. dollars and are issued by either a U.S. or non-U.S. bank evidencing ownership of underlying foreign securities. Even where they are denominated in U.S. dollars, depositary
receipts are subject to currency risk if the underlying security is denominated in a foreign currency. EDRs are issued in bearer form and are designed for use in European securities markets. GDRs are tradable both in the United States and Europe and
are designed for use throughout the world.
Securities of Emerging Markets Issuers.
Investors are strongly advised to
consider carefully the special risks involved in emerging markets, which are in addition to the usual risks of investing in developed foreign markets around the world.
The risks of investing in securities in emerging countries include: (i) less social, political and economic stability; (ii) the smaller size of the markets for such securities and lower volume
of trading, which result in a lack of liquidity and in greater price volatility; (iii) certain national policies that may restrict the funds investment opportunities, including restrictions on investment in issuers or industries deemed
sensitive to national interests; (iv) foreign taxation; and (v) the absence of developed structures governing private or foreign investment or allowing for judicial redress for injury to private property.
Investors should note that upon the accession to power of authoritarian regimes, the governments of a number of emerging market countries
previously expropriated large quantities of real and personal property similar to the property which may be represented by the securities purchased by the fund. The claims of property owners against those governments were never finally settled.
There can be no assurance that any property represented by securities purchased by the fund will not also be expropriated, nationalized or otherwise confiscated at some time in the future. If such confiscation were to occur, the fund could lose a
substantial portion or all of its investments in such countries. The funds investments would similarly be adversely affected by exchange control regulation in any of those countries.
Certain countries in which the fund may invest may have vocal minorities that advocate radical religious or revolutionary philosophies or
support ethnic independence. Any disturbance on the part of such individuals could carry the potential for widespread destruction or confiscation of property owned by individuals and entities foreign to such country and could cause the loss of the
funds investment in those countries.
Settlement mechanisms in emerging market securities may be less efficient and
reliable than in more developed markets. In such emerging securities markets there may be delays and failures in share registration and delivery.
Investing in emerging markets involves risks relating to potential political and economic instability within such markets and the risks of expropriation, nationalization, confiscation of assets and
property, the imposition of restrictions on foreign investments and the repatriation of capital invested. In addition, it may be difficult for the fund to pursue claims against a foreign issuer in the courts of a foreign country.
Inflation and rapid fluctuations in inflation rates have had, and may continue to have, very negative effects on the economies and
securities markets of certain emerging markets. Economies in emerging markets generally
9
are heavily dependent upon international trade and, accordingly, have been and may continue to be affected adversely and significantly by economic conditions, trade barriers, exchange controls,
managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade.
While some emerging market countries have sought to develop a number of corrective mechanisms to reduce inflation or mitigate its effects, inflation may continue to have significant effects both on
emerging market economies and their securities markets. In addition, many of the currencies of emerging market countries have experienced steady devaluations relative to the U.S. dollar, and major devaluations have occurred in certain countries.
Because of the high levels of foreign-denominated debt owed by many emerging market countries, fluctuating exchange rates can
significantly affect the debt service obligations of those countries. This could, in turn, affect local interest rates, profit margins and exports, which are a major source of foreign exchange earnings.
To the extent an emerging market country faces a liquidity crisis with respect to its foreign exchange reserves, it may increase
restrictions on the outflow of any foreign exchange. Repatriation is ultimately dependent on the ability of the fund to liquidate its investments and convert the local currency proceeds obtained from such liquidation into U.S. dollars. Where this
conversion must be done through official channels (usually the central bank or certain authorized commercial banks), the ability to obtain U.S. dollars is dependent on the availability of such U.S. dollars through those channels and, if available,
upon the willingness of those channels to allocate those U.S. dollars to the fund. The funds ability to obtain U.S. dollars may be adversely affected by any increased restrictions imposed on the outflow of foreign exchange. If the fund is
unable to repatriate any amounts due to exchange controls, it may be required to accept an obligation payable at some future date by the central bank or other governmental entity of the jurisdiction involved. If such conversion can legally be done
outside official channels, either directly or indirectly, the funds ability to obtain U.S. dollars may not be affected as much by any increased restrictions except to the extent of the price which may be required to be paid for in U.S.
dollars.
Many emerging market countries have little experience with the corporate form of business organization and may not
have well-developed corporation and business laws or concepts of fiduciary duty in the business context.
The securities
markets of emerging markets are substantially smaller, less developed, less liquid and more volatile than the securities markets of the United States and other more developed countries. Disclosure and regulatory standards in many respects are less
stringent than in the United States and other major markets. There also may be a lower level of monitoring and regulation of emerging markets and the activities of investors in such markets; enforcement of existing regulations has been extremely
limited. Investing in the securities of companies in emerging markets may entail special risks relating to the potential political and economic instability and the risks of expropriation, nationalization, confiscation or the imposition of
restrictions on foreign investment, convertibility of currencies into U.S. dollars and on repatriation of capital invested. In the event of such expropriation, nationalization or other confiscation by any country, the fund could lose its entire
investment in any such country.
Some emerging markets have different settlement and clearance procedures. In certain markets
there have been times when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct such transactions. The inability of the fund to make intended securities purchases due to settlement
problems could cause the fund to miss attractive investment opportunities. Inability to dispose of a portfolio security caused by settlement problems could result either in losses to the fund due to subsequent declines in the value of the portfolio
security or, if the fund has entered into a contract to sell the security, in possible liability to the purchaser. The risk also exists that an emergency situation may arise in one or more emerging markets as a result of which trading of securities
may cease or may be substantially curtailed and prices
10
for the funds portfolio securities in such markets may not be readily available. Section 22(e) of the 1940 Act permits a registered investment company to suspend redemption of its
shares for any period during which an emergency exists, as determined by the SEC. Accordingly, if the fund believes that appropriate circumstances warrant, it will promptly apply to the SEC for a determination that an emergency exists within the
meaning of Section 22(a) of the 1940 Act. During the period commencing from the funds identification of such conditions until the date of SEC action, the portfolio securities in the affected markets will be valued at fair value as
determined in good faith by or under the direction of the Board.
Although it might be theoretically possible to hedge for
anticipated income and gains, the ongoing and indeterminate nature of the risks associated with emerging market investing (and the costs associated with hedging transactions) makes it very difficult to hedge effectively against such risks.
One or more of the risks discussed above could affect adversely the economy of a developing market or the funds
investments in such a market. In Eastern Europe, for example, upon the accession to power of Communist regimes in the past, the governments of a number of Eastern European countries expropriated a large amount of property. The claims of many
property owners against those of governments may remain unsettled. There can be no assurance that any investments that the fund might make in such emerging markets would not be expropriated, nationalized or otherwise confiscated at some time in the
future. In such an event, the fund could lose its entire investment in the market involved. Moreover, changes in the leadership or policies of such markets could halt the expansion or reverse the liberalization of foreign investment policies now
occurring in certain of these markets and adversely affect existing investment opportunities.
Many of the funds
investments in the securities of emerging markets may be unrated or rated below investment grade. Securities rated below investment grade (and comparable unrated securities) are the equivalent of high yield, high risk bonds, commonly known as
junk bonds. Such securities are regarded as predominantly speculative with respect to the issuers capacity to pay interest and repay principal in accordance with the terms of the obligations and involve major risk exposure to
adverse business, financial, economic, or political conditions.
Currency Risks.
The U.S. dollar value of securities
denominated in a foreign currency will vary with changes in currency exchange rates, which can be volatile. Accordingly, changes in the value of the currency in which the funds investments are denominated relative to the U.S. dollar will
affect the funds NAV. Exchange rates are generally affected by the forces of supply and demand in the international currency markets, the relative merits of investing in different countries and the intervention or failure to intervene of U.S.
or foreign governments and central banks. However, currency exchange rates may fluctuate based on factors intrinsic to a countrys economy. Some emerging market countries also may have managed currencies, which are not free floating against the
U.S. dollar. In addition, emerging markets are subject to the risk of restrictions upon the free conversion of their currencies into other currencies. Any devaluations relative to the U.S. dollar in the currencies in which the funds securities
are quoted would reduce the funds NAV per share.
Sovereign Government and Supranational Debt.
The fund may
invest in all types of debt securities of governmental issuers in all countries, including emerging markets. These sovereign debt securities may include: debt securities issued or guaranteed by governments, governmental agencies or instrumentalities
and political subdivisions located in emerging market countries; debt securities issued by government owned, controlled or sponsored entities located in emerging market countries; interests in entities organized and operated for the purpose of
restructuring the investment characteristics of instruments issued by any of the above issuers; Brady Bonds, which are debt securities issued under the framework of the Brady Plan as a means for debtor nations to restructure their outstanding
external indebtedness; participations in loans between emerging market governments and financial institutions; or debt securities issued by supranational entities such as the World Bank or the European Economic Community. A supranational entity is a
bank, commission or company established or financially supported by the national governments of one or more countries to promote reconstruction or development.
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Sovereign debt is subject to risks in addition to those relating to non-U.S. investments
generally. As a sovereign entity, the issuing government may be immune from lawsuits in the event of its failure or refusal to pay the obligations when due. The debtors willingness or ability to repay in a timely manner may be affected by,
among other factors, its cash flow situation, the extent of its non-U.S. reserves, the availability of sufficient non-U.S. exchange on the date a payment is due, the relative size of the debt service burden to the economy as a whole, the sovereign
debtors policy toward principal international lenders and the political constraints to which the sovereign debtor may be subject. Sovereign debtors may also be dependent on disbursements or assistance from foreign governments or multinational
agencies, the countrys access to trade and other international credits, and the countrys balance of trade. Assistance may be dependent on a countrys implementation of austerity measures and reforms, which measures may limit or be
perceived to limit economic growth and recovery. Some sovereign debtors have rescheduled their debt payments, declared moratoria on payments or restructured their debt to effectively eliminate portions of it, and similar occurrences may happen in
the future. There is no bankruptcy proceeding by which sovereign debt on which governmental entities have defaulted may be collected in whole or in part.
Money Market Instruments.
The fund may invest for temporary defensive purposes in corporate and government bonds and notes and money market instruments. Money market instruments in which the fund
may invest include: obligations issued or guaranteed by the U.S. government, its agencies or instrumentalities (U.S. government securities); certificates of deposit (CDs), time deposits (TDs) and bankers
acceptances issued by domestic banks (including their branches located outside the United States and subsidiaries located in Canada), domestic branches of foreign banks, savings and loan associations and similar institutions; high grade commercial
paper; and repurchase agreements with respect to the foregoing types of instruments. The following is a more detailed description of such money market instruments.
CDs are short-term negotiable obligations of commercial banks. TDs are non-negotiable deposits maintained in banking institutions for specified periods of time at stated interest rates. Bankers
acceptances are time drafts drawn on commercial banks by borrowers usually in connection with international transactions.
Recently enacted legislation will affect virtually every area of banking and financial regulation. The extent and impact of the
regulations are not yet fully known and may not be for some time. In addition, new regulations to be promulgated pursuant to the legislation could adversely affect the funds investments in money market instruments.
Domestic commercial banks organized under federal law are supervised and examined by the Comptroller of the Currency (the
COTC) and are required to be members of the Federal Reserve System and to be insured by the Federal Deposit Insurance Corporation (the FDIC). Domestic banks organized under state law are supervised and examined by state
banking authorities but are members of the Federal Reserve System only if they elect to join. Most state banks are insured by the FDIC (although such insurance may not be of material benefit to the fund, depending upon the principal amount of CDs of
each bank held by the fund) and are subject to federal examination and to a substantial body of federal law and regulation. As a result of governmental regulations, domestic branches of domestic banks are, among other things, generally required to
maintain specified levels of reserves, and are subject to other supervision and regulation.
Obligations of foreign branches
of domestic banks, such as CDs and TDs, may be general obligations of the parent bank in addition to the issuing branch, or may be limited by the terms of a specific obligation and government regulation. Such obligations are subject to different
risks than are those of domestic banks or domestic branches of foreign banks. These risks include foreign economic and political developments, foreign governmental restrictions that may adversely affect payment of principal and interest on the
obligations, foreign exchange controls and foreign withholding and other taxes on interest income. Foreign branches of domestic banks are not necessarily subject to the same or similar regulatory requirements that apply to domestic banks, such as
mandatory reserve requirements, loan limitations, and accounting, auditing and financial recordkeeping requirements. In addition, less information may be publicly available about a foreign branch of a domestic bank than about a domestic bank.
12
Obligations of domestic branches of foreign banks may be general obligations of the parent
bank in addition to the issuing branch, or may be limited by the terms of a specific obligation and by governmental regulation as well as governmental action in the country in which the foreign bank has its head office. A domestic branch of a
foreign bank with assets in excess of $1 billion may or may not be subject to reserve requirements imposed by the Federal Reserve System or by the state in which the branch is located if the branch is licensed in that state. In addition, branches
licensed by the COTC and branches licensed by certain states (State Branches) may or may not be required to: (a) pledge to the regulator by depositing assets with a designated bank within the state, an amount of its assets equal to
5% of its total liabilities; and (b) maintain assets within the state in an amount equal to a specified percentage of the aggregate amount of liabilities of the foreign bank payable at or through all of its agencies or branches within the
state. The deposits of State Branches may not necessarily be insured by the FDIC. In addition, there may be less publicly available information about a domestic branch of a foreign bank than about a domestic bank.
In view of the foregoing factors associated with the purchase of CDs and TDs issued by foreign branches of domestic banks or by domestic
branches of foreign banks, Western Asset Management Company (Western Asset) will carefully evaluate such investments on a case-by-case basis.
Commercial Paper.
Commercial paper consists of short-term (usually from 1 to 270 days) unsecured promissory notes issued by corporations in order to finance their current operations. The fund may
invest in short-term debt obligations of issuers that at the time of purchase are rated A-2, A-1 or A-1+ by Standard & Poors Financial Services LLC, a subsidiary of The McGraw-Hill Companies, Inc. (S&P) or Prime-2 or
Prime-1 by Moodys Investors Service, Inc. (Moodys) or, if unrated, are issued by companies having an outstanding unsecured debt issue currently rated within the two highest ratings of S&P or Moodys.
Fixed Income Securities
Issuer Risk.
The value of fixed income securities issued by corporations may decline for a number of reasons which directly relate to the issuer such as management performance, financial leverage
or reduced demand for the issuers goods and services.
Interest Rate Risk.
When interest rates decline, the
market value of fixed income securities tends to increase. Conversely, when interest rates increase, the market value of fixed income securities tends to decline. The volatility of a securitys market value will differ depending upon the
securitys duration, the issuer and the type of instrument.
Default Risk/Credit Risk.
Investments in fixed income
securities are subject to the risk that the issuer of the security could default on its obligations, causing the fund to sustain losses on such investments. A default could impact both interest and principal payments.
Call Risk and Extension Risk.
Fixed income securities may be subject to both call risk and extension risk. Call risk exists when
the issuer may exercise its right to pay principal on an obligation earlier than scheduled, which would cause cash flows to be returned earlier than expected. This typically results when interest rates have declined and the fund will suffer from
having to reinvest in lower yielding securities. Extension risk exists when the issuer may exercise its right to pay principal on an obligation later than scheduled, which would cause cash flows to be returned later than expected. This typically
results when interest rates have increased, and the fund will suffer from the inability to invest in higher yield securities.
Debt Securities.
Corporate debt securities are bonds or notes issued by corporations and other business organizations, including
business trusts, in order to finance their credit needs. Corporate debt securities include commercial paper, which consists of short-term (usually from 1 to 270 days) unsecured promissory notes issued by corporations in order to finance their
current operations.
13
Corporate debt securities may pay fixed or variable rates of interest, or interest at a rate
contingent upon some other factor, such as the price of some commodity. These securities may be convertible into preferred or common stock, or may be bought as part of a unit containing common stock. In selecting corporate debt securities for the
fund, the subadviser reviews and monitors the creditworthiness of each issuer and issue. The subadviser also analyzes interest rate trends and specific developments that it believes may affect individual issuers.
The prices of debt securities fluctuate in response to perceptions of the issuers creditworthiness and also tend to vary inversely
with market interest rates. The value of such securities is likely to decline in times of rising interest rates. Conversely, when rates fall, the value of these investments is likely to rise. The longer the time to maturity the greater are such
variations.
Debt securities rated BBB/Baa or better by S&P or Moodys and unrated securities considered by the
funds subadviser to be of equivalent quality are considered investment grade. Debt securities rated below BBB/Baa, commonly known as junk bonds, which the fund may purchase from time to time, are deemed by the ratings companies to
be speculative and may involve major risk of exposure to adverse conditions. The prices of lower-rated securities, especially junk bonds, often are more volatile than those of higher-rated securities, and the security may be difficult to sell. Those
in the lowest rating categories may involve a substantial risk of default or may be in default. Changes in economic conditions or developments regarding the individual issuer are more likely to cause price volatility and weaken the capacity of such
securities to make principal and interest payments than is the case for higher grade debt securities. Securities rated below BBB/Baa may be less liquid than higher-rated securities, which means the fund may have difficulty selling them at times, and
may have to apply a greater degree of judgment in establishing a price for purposes of valuing shares of the fund. Moodys considers debt securities rated in the lowest investment grade category (Baa) to have speculative characteristics. A
description of the rating assigned to corporate debt securities is included in Appendix A.
The market for lower-rated debt
securities is generally thinner and less active than that for higher quality debt securities, which may limit the funds ability to sell such securities at fair value. Judgment plays a greater role in pricing such securities than is the case
for securities having more active markets. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may also decrease the values and liquidity of lower-rated debt securities, especially in a thinly traded market.
In addition to ratings assigned to individual bond issues, the subadviser will analyze interest rate trends and developments
that may affect individual issuers, including factors such as liquidity, profitability and asset quality. The yields on bonds and other debt securities in which the fund invests are dependent on a variety of factors, including general money market
conditions, general conditions in the bond market, the financial conditions of the issuer, the size of the offering, the maturity of the obligation and its rating. There may be a wide variation in the quality of bonds, both within a particular
classification and between classifications. A bond issuers obligations are subject to the provisions of bankruptcy, insolvency and other laws affecting the rights and remedies of bond holders or other creditors of an issuer; litigation or
other conditions may also adversely affect the power or ability of bond issuers to meet their obligations for the payment of principal and interest. Regardless of rating levels, all debt securities considered for purchase (whether rated or unrated)
are analyzed by the subadviser to determine, to the extent possible, that the planned investment is sound.
The fund may
invest in foreign corporate debt securities denominated in U.S. dollars or foreign currencies. Foreign debt securities include Yankee dollar obligations (U.S. dollar denominated securities issued by foreign corporations and traded on U.S. markets)
and Eurodollar obligations (U.S. dollar denominated securities issued by foreign corporations and traded on foreign markets).
The fund may invest in the debt securities of governmental or corporate issuers in any rating category of the recognized rating agencies,
including issues that are in default, and may invest in unrated debt obligations. Most foreign debt obligations are not rated. Debt securities and securities convertible into common stock need not
14
necessarily be of a certain grade as determined by rating agencies such as S&P or Moodys; however, the subadviser does consider such ratings in determining whether the security is an
appropriate investment for the fund.
Mortgage-Backed and Asset-Backed Securities.
The fund may purchase fixed or
adjustable rate mortgage-backed securities (MBS) issued by the Government National Mortgage Association (Ginnie Mae), Fannie Mae (formally known as the Federal National Mortgage Association) or Freddie Mac (formally
known as the Federal Home Loan Mortgage Corporation), and other asset-backed securities (ABS), including securities backed by automobile loans, equipment leases or credit card receivables. Ginnie Mae is a wholly owned U.S. government
corporation within the Department of Housing and Urban Development. The mortgage-backed securities guaranteed by Ginnie Mae are backed by the full faith and credit of the United States. Fannie Mae and Freddie Mac are stockholder-owned companies
chartered by Congress. Fannie Mae and Freddie Mac guarantee the securities they issue as to timely payment of principal and interest, but such guarantee is not backed by the full faith and credit of the United States. These securities directly or
indirectly represent a participation in, or are secured by and payable from, fixed or adjustable rate mortgage or other loans which may be secured by real estate or other assets. Unlike traditional debt instruments, payments on these securities
include both interest and a partial payment of principal. Prepayments of the principal of underlying loans may shorten the effective maturities of these securities and may result in the fund having to reinvest proceeds at a lower interest rate. The
fund may also purchase collateralized mortgage obligations, which are a type of bond secured by an underlying pool of mortgages, or mortgage pass-through certificates that are structured to direct payments on underlying collateral to different
series or classes of the obligations.
MBS may be issued by private companies or by agencies of the U.S. government and
represent direct or indirect participations in, or are collateralized by and payable from, mortgage loans secured by real property. ABS represent participations in, or are secured by and payable from, assets such as installment sales or loan
contracts, leases, credit card receivables and other categories of receivables. Certain debt instruments may only pay principal at maturity or may only represent the right to receive payments of principal or payments of interest on underlying pools
of mortgages, assets or government securities, but not both. The value of these types of instruments may change more drastically than debt securities that pay both principal and interest. The fund may obtain a below market yield or incur a loss on
such instruments during periods of declining interest rates. Principal only and interest only instruments are subject to extension risk. For mortgage derivatives and structured securities that have imbedded leverage features, small changes in
interest or prepayment rates may cause large and sudden price movements. Mortgage derivatives can also become illiquid and hard to value in declining markets. Certain MBS or ABS may provide, upon the occurrence of certain triggering events or
defaults, for the investors to become the holders of the underlying assets. In that case, the fund may become the holder of securities that it could not otherwise purchase, based on its investment strategies or its investment restrictions and
limitations, at a time when such securities may be difficult to dispose of because of adverse market conditions.
Commercial
banks, savings and loan institutions, mortgage bankers and other secondary market issuers, such as dealers, create pass-through pools of conventional residential mortgage loans. Such issuers also may be the originators of the underlying mortgage
loans. Pools created by such non-governmental issuers generally offer a higher rate of interest than government and government-related pools because there are no direct or indirect government guarantees of payments with respect to such pools.
However, timely payment of interest and principal of these pools is supported by various forms of insurance or guarantees, including individual loan, title, pool and hazard insurance. There can be no assurance that the private insurers can meet
their obligations under the policies. The fund may buy mortgage-related securities without insurance or guarantees if, through an examination of the loan experience and practices of the persons creating the pools, the subadviser determines that the
securities are an appropriate investment for the fund.
When-Issued and Delayed Delivery Transactions.
In order to
secure yields or prices deemed advantageous at the time, the fund may purchase or sell securities on a when-issued or delayed-delivery basis. The fund will enter into a when-issued transaction for the purpose of acquiring portfolio securities and
not for the purpose of
15
leverage. In when-issued or delayed-delivery transactions, delivery of the securities occurs beyond normal settlement periods, but no payment or delivery will be made by the fund prior to the
actual delivery or payment by the other party to the transaction. The fund will not accrue income with respect to a when-issued or delayed-delivery security prior to its stated delivery date. In entering into a when-issued or delayed-delivery
transaction, the fund relies on the other party to consummate the transaction and may be disadvantaged if the other party fails to do so.
Purchasing such securities involves the risk of loss if the value of the securities declines prior to settlement date. The sale of securities for delayed delivery involves the risk that the prices
available in the market on the delivery date may be greater than those obtained in the sale transaction. The fund will at all times maintain in a segregated account at its custodian cash or liquid assets equal to the amount of the funds
when-issued or delayed-delivery commitments. For the purpose of determining the adequacy of the securities in the account, the deposited securities will be valued at market or fair value. If the market or fair value of such securities declines,
additional cash or securities will be placed in the account on a daily basis so that the value of the account will equal the amount of such commitments by the fund. Placing securities rather than cash in the account may have a leveraging effect on
the funds assets. That is, to the extent that the fund remains substantially fully invested in securities at the time that it has committed to purchase securities on a when-issued basis, there will be greater fluctuation in its NAV than if it
had set aside cash to satisfy its purchase commitments. On the settlement date, the fund will meet its obligations from then available cash flow, the sale of securities held in the separate account, the sale of other securities or, although it
normally would not expect to do so, from the sale of the when-issued or delayed-delivery securities themselves (which may have a greater or lesser value than the funds payment obligations).
Other Fixed Income Securities.
The fund may also invest in other types of fixed income securities which are subordinated or
junior to more senior securities of the issuer, or which represent interests in pools of such subordinated or junior securities. Such securities may include preferred stock. Under the terms of subordinated securities, payments that would
otherwise be made to their holders may be required to be made to the holders of more senior securities, and/or the subordinated or junior securities may have junior liens, if they have any rights at all, in any collateral (meaning proceeds of the
collateral are required to be paid first to the holders of more senior securities). As a result, subordinated or junior securities will be disproportionately adversely affected by a default or even a perceived decline in creditworthiness of the
issuer.
Zero Coupon Securities.
The fund may invest in zero coupon securities. Zero coupon securities
generally pay no cash interest (or dividends in the case of preferred stock) to their holders prior to maturity. Accordingly, such securities usually are issued and traded at a deep discount from their face or par value and generally are subject to
greater fluctuations of market value in response to changing interest rates than securities of comparable maturities and credit quality that pay cash interest (or dividends in the case of preferred stock) on a current basis. The values of these
securities may be highly volatile as interest rates rise or fall. In addition, the funds investments in zero coupon securities will result in special tax consequences. Although zero coupon securities do not make interest payments, for tax
purposes, a portion of the difference between a zero coupon securitys stated redemption price at maturity and its issue price is taxable income of the fund each year. The value of zero coupon bonds is subject to greater fluctuation in market
value in response to changes in market interest rates than bonds of comparable maturity which pay interest currently. Zero coupon bonds allow an issuer to avoid the need to generate cash to meet current interest payments. Accordingly, such bonds may
involve greater credit risks than bonds that pay interest currently. Even though such bonds do not pay current interest in cash, the fund is nonetheless required to accrue interest income on such investments and to distribute such amounts at least
annually to shareholders. Accordingly, for the fund to continue to qualify for tax treatment as a regulated investment company and to avoid income and possibly excise tax, the fund may be required to distribute as a dividend an amount that is
greater than the total amount of cash it actually receives. These distributions must be made from the funds cash assets or, if necessary, from the proceeds of sales of portfolio securities. The fund will not be able to purchase additional
income-producing securities with cash used to make such distributions and its current income ultimately may be reduced as a result.
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U.S. Government Securities.
The fund may invest in U.S. government securities, which
include (1) U.S. Treasury bills (maturity of one year or less), U.S. Treasury notes (maturity of one to ten years) and U.S. Treasury bonds (maturities generally greater than ten years) and (2) obligations issued or guaranteed by U.S.
government agencies or instrumentalities which are supported by any of the following: (a) the full faith and credit of the U.S. government; (b) the right of the issuer to borrow an amount limited to specific line of credit from the U.S.
government (such as obligations of the Federal Home Loan Banks); (c) the discretionary authority of the U.S. government to purchase certain obligations of agencies or instrumentalities (such as securities issued by Fannie Mae); or (d) only
the credit of the instrumentality (such as securities issued by Freddie Mac). In the case of obligations not backed by the full faith and credit of the United States, the fund must look principally to the agency or instrumentality issuing or
guaranteeing the obligation for ultimate repayment and may not be able to assert a claim against the U.S. government itself in the event the agency or instrumentality does not meet its commitments. Therefore, the fund will invest in obligations
issued by such an instrumentality only if the funds subadviser determines the credit risk with respect to the instrumentality does not make its securities unsuitable for investment by the fund. Neither the U.S. government nor any of its
agencies or instrumentalities guarantees the market value of the securities they issue. Therefore, the market value of such securities will fluctuate in response to changes in interest rates.
Variable Rate Demand Notes.
The fund may invest in variable rate master demand notes, which typically are issued by large
corporate borrowers providing for variable amounts of principal indebtedness and periodic adjustments in the interest rate according to the terms of the instrument. Variable rate demand notes are direct lending arrangements between the fund and an
issuer, and are not normally traded in a secondary market. The fund, however, may demand payment of principal and accrued interest at any time. In addition, while variable rate demand notes generally are not rated, their issuers must satisfy the
same criteria as those set forth above for issuers of commercial paper. The subadviser will consider the earning power, cash flow and other liquidity ratios of issuers of variable rate demand notes and continually will monitor their financial
ability to meet payment on demand.
Derivatives.
General.
The fund may invest in certain derivative instruments (also called Financial Instruments), discussed below, to attempt to hedge its investments, among other things as described
in the Prospectus. The use of Financial Instruments is subject to applicable regulations of the SEC, the several exchanges upon which they are traded and the Commodity Futures Trading Commission (the CFTC). In addition, the funds
ability to use Financial Instruments may be limited by tax considerations. In addition to the instruments, strategies and risks described below, the subadviser expects that additional opportunities in connection with Financial Instruments and other
similar or related techniques may become available. These new opportunities may become available as the subadviser develops new techniques, as regulatory authorities broaden the range of permitted transactions and as new Financial Instruments or
other techniques are developed. The subadviser may utilize these opportunities to the extent that they are consistent with the funds investment objective and are permitted by its investment limitations and applicable regulatory authorities.
The fund might not use any of these strategies, and there can be no assurance that any strategy used will succeed.
Recent
legislation calls for new regulation of the derivatives markets. The extent and impact of the regulations are not yet fully known and may not be for some time. Any new regulations could adversely affect the value, availability and performance of
Financial Instruments, may make them more costly, and may limit or restrict their use by the fund.
Each Financial Instrument
purchased for the fund is reviewed and analyzed by the subadviser to assess the risk and reward of each such instrument in relation to the funds investment strategy. The decision to invest in derivative instruments or conventional securities
is made by measuring the respective instruments ability to provide value to the fund.
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Hedging strategies can be broadly categorized as short hedges and long
hedges. A short hedge is a purchase or sale of a Financial Instrument intended partially or fully to offset potential declines in the value of one or more investments held in the funds portfolio. In a short hedge, the fund takes a
position in a Financial Instrument whose price is expected to move in the opposite direction of the price of the investment being hedged.
Conversely, a long hedge is a purchase or sale of a Financial Instrument intended partially or fully to offset potential increases in the acquisition cost of one or more investments that the fund intends
to acquire. In a long hedge, the fund takes a position in a Financial Instrument whose price is expected to move in the same direction as the price of the prospective investment being hedged. A long hedge is sometimes referred to as an anticipatory
hedge. In an anticipatory hedge transaction, the fund does not own a corresponding security and, therefore, the transaction does not relate to a security the fund owns. Rather, it relates to a security that the fund intends to acquire. If the fund
does not complete the hedge by purchasing the security as anticipated, the effect on the funds portfolio is the same as if the transaction were entered into for speculative purposes.
Financial Instruments on securities may be used to attempt to hedge against price movements in one or more particular securities
positions that the fund owns or intends to acquire. Financial Instruments on indexes, in contrast, may be used to attempt to hedge against price movements in market sectors in which the fund has invested or expects to invest. Financial Instruments
on debt securities may be used to hedge either individual securities or broad debt market sectors.
Special Risks.
The
use of Financial Instruments involves special considerations and risks, certain of which are described below. In general, these techniques may increase the volatility of the fund and may involve a small investment of cash relative to the magnitude
of the risk assumed.
(1) Successful use of most Financial Instruments depends upon the subadvisers
ability to predict movements of the overall securities, currency and interest rate markets, which requires different skills than predicting changes in the prices of individual securities. There can be no assurance that any particular strategy will
succeed, and use of Financial Instruments could result in a loss, regardless of whether the intent was to enhance returns or manage risk.
(2) When Financial Instruments are used for hedging purposes, the historical correlation between price movements of a Financial Instrument and price movements of the investments being hedged might change
so as to make the hedge less effective or unsuccessful. For example, if the value of a Financial Instrument used in a short hedge increased by less than the decline in value of the hedged investment, the hedge would not be fully successful. Such a
change in correlation might occur due to factors unrelated to the value of the investments being hedged, such as speculative or other pressures on the markets in which Financial Instruments are traded. The effectiveness of hedges using Financial
Instruments on indexes will depend on the degree to which correlation between price movements in the index and price movements in the securities being hedged can be accurately predicted.
Because there are a limited number of types of exchange-traded options and futures contracts, it is likely that the
standardized contracts available will not match the funds current or anticipated investments exactly. The fund may invest in options and futures contracts based on securities with different issuers, maturities or other characteristics from the
securities in which it typically invests, which involves the risk that the options or futures position will not track the performance of the funds other investments.
Options and futures prices can also diverge from the prices of their underlying instruments, even if the underlying
instruments match the funds investments well. Options and futures prices are affected by factors that may not affect security prices the same way, such as current and anticipated short-term interest rates, changes in volatility of the
underlying instrument, and the time remaining until expiration of the contract. Imperfect correlation may also result from differing levels of demand in the options and futures markets and the securities markets, from structural differences in how
options and futures are traded as compared to securities, or from the imposition of daily price fluctuation limits or trading halts. The fund may purchase or sell options and futures contracts with a greater or lesser value than the securities it
wishes to hedge or
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intends to purchase in order to attempt to compensate for differences in volatility between the contract and the securities, although this may not be successful in all cases. If price changes in
the funds options or futures positions have a low correlation with its other investments, the positions may fail to produce anticipated gains or result in losses that are not offset by gains in other investments.
(3) If successful, the hedging strategies discussed above can reduce the risk of loss by wholly or partially offsetting
the negative effect of unfavorable price movements. However, such strategies can also reduce opportunity for gain by offsetting the positive effect of favorable price movements. For example, if the fund entered into a short hedge because its
subadviser projected a decline in the price of a security in the funds portfolio, and the price of that security increased instead, the gain from that increase might be wholly or partially offset by a decline in the price of the Financial
Instrument. Moreover, if the price of the Financial Instrument declined by more than the increase in the price of the security, the fund could suffer a loss. In either such case, the fund would have been in a better position had it not attempted to
hedge at all.
(4) The fund might be required to maintain segregated assets as cover or make margin
payments when it takes positions in Financial Instruments involving obligations to third parties (
i.e.
, Financial Instruments other than purchased options). If the fund were unable to close out its positions in such Financial Instruments, it
might be required to continue to maintain such assets or accounts or make such payments until the position expired or matured. These requirements might impair the funds ability to sell a portfolio security or make an investment at a time when
it would otherwise be favorable to do so, or require that the fund sell a portfolio security at a disadvantageous time.
(5) The fund may be subject to the risk that the other party to a Financial Instrument (the counterparty) will not be able to honor its financial obligation to the fund.
(6) Many Financial Instruments are traded in institutional markets rather than on an exchange. Nevertheless, many
Financial Instruments are actively traded and can be priced with as much accuracy as conventional securities. Financial Instruments that are custom designed to meet the specialized investment needs of a relatively narrow group of institutional
investors such as the fund are not readily marketable and are subject to the funds restrictions on illiquid investments.
The funds ability to close out a position in a Financial Instrument prior to expiration or maturity depends on the existence of a liquid secondary market or, in the absence of such a market, the
ability and willingness of the counterparty to enter into a transaction closing out the position. Therefore, there is no assurance that any position can be closed out at a time and price that is favorable to the fund.
Options on Securities.
The fund may write covered call options and enter into closing transactions with respect thereto. The
principal reason for writing covered call options on securities is to attempt to realize, through the receipt of premiums, a greater return than would be realized on the securities alone. In return for a premium, the writer of a covered call option
forfeits the right to any appreciation in the value of the underlying security above the strike price for the life of the option (or until a closing purchase transaction can be effected). Nevertheless, the call writer retains the risk of a decline
in the price of the underlying security. The size of the premiums the fund may receive may be adversely affected as new or existing institutions, including other investment companies, engage in or increase their option-writing activities.
Options written by the fund will normally have expiration dates between one and six months from the date written. The
exercise price of the options may be below, equal to, or above the current market values of the underlying securities at the times options are written. In the case of call options, these exercise prices are referred to as in-the-money,
at-the-money and out-of-the-money, respectively. The fund may write (a) in-the-money call options when the subadviser expects the price of the underlying security to remain flat or decline moderately during the option
period, (b) at-the-money call options when the subadviser expects the price of the underlying security to remain flat or advance moderately during the option period and (c) out-of-the-money call options when the subadviser expects that the
price of the security may increase but not above a price equal to the sum of the exercise price plus the premiums received from writing the call option. In
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any of the preceding situations, if the market price of the underlying security declines and the security is sold at this lower price, the amount of any realized loss will be offset wholly or in
part by the premium received. Writing out-of-the-money, at-the-money and in-the-money put options (the reverse of call options as to the relation of exercise price to market price) may be utilized in the same market environments as such call options
are used in equivalent transactions.
So long as the obligation of the fund as the writer of an option continues, the fund may
be assigned an exercise notice by the broker/dealer through which the option was sold, requiring it to deliver, in the case of a call, or take delivery of, in the case of a put, the underlying security against payment of the exercise price. This
obligation terminates when the option expires or the fund effects a closing purchase transaction. The fund can no longer effect a closing purchase transaction with respect to an option once it has been assigned an exercise notice. To secure its
obligation to deliver the underlying security when it writes a call option, or to pay for the underlying security when it writes a put option, the fund will be required to deposit in escrow the underlying security or other assets in accordance with
the rules of the Options Clearing Corporation (OCC) or similar clearing corporation and the securities exchange on which the option is written.
An option position may be closed out only where there exists a secondary market for an option of the same series on a recognized securities exchange or in the over-the-counter (OTC) market.
The fund expects to write options only on national securities exchanges or in the OTC market. The fund may purchase put options issued by the OCC or in the OTC market. The fund may realize a profit or loss upon entering into a closing transaction.
In cases in which the fund has written an option, it will realize a profit if the cost of the closing purchase transaction is less than the premium received upon writing the original option and will incur a loss if the cost of the closing purchase
transaction exceeds the premium received upon writing the original option. Similarly, when the fund has purchased an option and engages in a closing sale transaction, whether it recognizes a profit or loss will depend upon whether the amount
received in the closing sale transaction is more or less than the premium the fund initially paid for the original option plus the related transaction costs.
Although the fund generally will purchase or write only those options for which the subadviser believes there is an active secondary market so as to facilitate closing transactions, there is no assurance
that sufficient trading interest to create a liquid secondary market on a securities exchange will exist for any particular option or at any particular time, and for some options no such secondary market may exist or option may cease to exist. In
the past, for example, higher than anticipated trading activity or order flow, or other unforeseen events, have at times rendered certain of the facilities of the OCC and national securities exchanges inadequate and resulted in the institution of
special procedures, such as trading rotations, restrictions on certain types of orders or trading halts or suspensions in one or more options. There can be no assurance that similar events, or events that may otherwise interfere with the timely
execution of customers orders, will not recur. In such event, it might not be possible to effect closing transactions in particular options. If, as a covered call option writer, the fund is unable to effect a closing purchase transaction in a
secondary market, it will not be able to sell the underlying security until the option expires or it delivers the underlying security upon exercise.
Securities exchanges generally have established limitations governing the maximum number of calls and puts of each class which may be held or written, or exercised within certain periods, by an investor
or group of investors acting in concert (regardless of whether the options are written on the same or different securities exchanges or are held, written or exercised in one or more accounts or through one or more brokers). It is possible that the
fund and other clients of the manager or subadviser and certain of their affiliates may be considered to be such a group. A securities exchange may order the liquidation of positions found to be in violation of these limits, and it may impose
certain other sanctions.
In the case of options written by the fund that are deemed covered by virtue of the funds
holding convertible or exchangeable preferred stock or debt securities, the time required to convert or exchange and obtain physical delivery of the underlying common stock with respect to which the fund has written options may exceed the time
within which the fund must make delivery in accordance with an exercise notice. In these
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instances, the fund may purchase or temporarily borrow the underlying securities for purposes of physical delivery. By so doing, the fund will not bear any market risk because the fund will have
the absolute right to receive from the issuer of the underlying security an equal number of shares to replace the borrowed stock, but the fund may incur additional transaction costs or interest expenses in connection with any such purchase or
borrowing.
Although the subadviser will attempt to take appropriate measures to minimize the risks relating to the
funds writing of call options and purchasing of put and call options, there can be no assurance that the fund will succeed in its option-writing program.
Stock Index Options.
A stock index fluctuates with changes in the market values of the stocks included in the index. Some stock index options are based on a broad market index such as the NYSE
Composite Index or the Canadian Market Portfolio Index, or a narrower market or industry index such as the S&P 100 Index, the NYSE Arca Oil Index or the NYSE Arca Computer Technology Index.
Options on stock indexes are generally similar to options on stock except for the delivery requirements. Instead of giving the right to
take or make delivery of stock at a specified price, an option on a stock index gives the holder the right to receive a cash exercise settlement amount equal to (a) the amount, if any, by which the fixed exercise price of the option
exceeds (in the case of a put) or is less than (in the case of a call) the closing value of the underlying index on the date of exercise, multiplied by (b) a fixed index multiplier. Receipt of this cash amount will depend upon the
closing level of the stock index upon which the option is based being greater than, in the case of a call, or less than, in the case of a put, the exercise price of the option. The amount of cash received will be equal to such difference between the
closing price of the index and the exercise price of the option expressed in dollars or a foreign currency, as the case may be, times a specified multiple. The writer of the option is obligated, in return for the premium received, to make delivery
of this amount. The writer may offset its position in stock index options prior to expiration by entering into a closing transaction on an exchange or it may let the option expire unexercised.
The effectiveness of purchasing or writing stock index options as a hedging technique will depend upon the extent to which price
movements in the portion of the securities portfolio of the fund being hedged correlate with price movements of the stock index selected. Because the value of an index option depends upon movements in the level of the index rather than the price of
a particular stock, whether the fund will realize a gain or loss from the purchase or writing of options on an index depends upon movements in the level of stock prices in the stock market generally or, in the case of certain indexes, in an industry
or market segment, rather than movements in the price of a particular stock. Accordingly, successful use by the fund of options on stock indexes will be subject to the subadvisers ability to predict correctly movements in the direction of the
stock market generally or of a particular industry. This requires different skills and techniques than predicting changes in the price of individual stocks.
Futures and Options on Futures.
When deemed advisable by the subadviser, the fund may enter into interest rate futures contracts, stock index futures contracts and related options that are traded
on a domestic exchange or board of trade. These transactions may, but need not, use derivative contracts, such as futures and options on securities or securities indices, options on these futures, and interest rate futures, for the purpose of
hedging against the economic impact of adverse changes in the market value of portfolio securities, because of changes in interest rates or stock prices, or as a substitute for buying or selling securities or as a cash flow management technique.
An interest rate futures contract provides for the future sale by the one party and the purchase by the other party of a
specified amount of a particular financial instrument (debt security) at a specified price, date, time and place. A stock index futures contract is an agreement pursuant to which two parties agree to take or make delivery of an amount of cash equal
to the difference between the value of the index at the close of the last trading day of the contract and the price at which the index contract was originally entered into. Stock index
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futures contracts are based on indexes that reflect the market value of common stock of the companies included in the indexes. An option on an interest rate or stock index contract gives the
purchaser the right, in return for the premium paid, to assume a position in a futures contract (a long position if the option is a call and a short position if the option is a put) at a specified exercise price at any time prior to the expiration
date of the option. When the fund buys or sells a futures contract, it incurs a contractual obligation to receive or deliver the underlying instrument (or a cash payment based on the difference between the underlying instruments closing price
and the price at which the contract was entered into) at a specified price on a specified date. For example, in the case of stock index futures contracts, if the fund anticipates an increase in the price of stocks that it intends to purchase at a
later time, the fund could enter into contracts to purchase the stock index (known as taking a long position) as a temporary substitute for the purchase of stocks. If an increase in the market occurs that influences the stock index as
anticipated, the value of the futures contracts increases and thereby serves as a hedge against the funds not participating in a market advance. The fund then may close out the futures contracts by entering into offsetting futures contracts to
sell the stock index (known as taking a short position) as it purchases individual stocks. The fund can accomplish similar results by buying securities with long maturities and selling securities with short maturities. But by using
futures contracts as an investment tool to reduce risk, given the greater liquidity in the futures market, it may be possible to accomplish the same result more easily and more quickly.
Although futures contracts by their terms call for the delivery or acquisition of the underlying commodities or a cash payment based on
the value of the underlying commodities, in most cases the contractual obligation is offset before the delivery date of the contract by buying, in the case of a contractual obligation to sell, or selling, in the case of a contractual obligation to
buy, an identical futures contract on a commodities exchange. Such a transaction cancels the obligation to make or take delivery of the commodities. Since all transactions in the futures market are made through a member of, and are offset or
fulfilled through a clearinghouse associated with, the exchange on which the contracts are traded, the fund will incur brokerage fees when it buys or sells futures contracts.
No consideration will be paid or received by the fund upon the purchase or sale of a futures contract. Initially, the fund will be required to deposit with the broker an amount of cash or cash equivalents
equal to approximately 1% to 10% of the contract amount (this amount is subject to change by the exchange or board of trade on which the contract is traded and brokers or members of such board of trade may charge a higher amount). This amount is
known as initial margin and is in the nature of a performance bond or good faith deposit on the contract, which is returned to the fund upon termination of the futures contract, assuming all contractual obligations have been satisfied.
Subsequent payments, known as variation margin, to and from the broker, will be made daily as the price of the index or securities underlying the futures contract fluctuates, making the long and short positions in the futures contract
more or less valuable, a process known as marking-to-market. In addition, when the fund enters into a long position in a futures contract or an option on a futures contract, it must maintain an amount of cash or cash equivalents equal to
the total market value of the underlying futures contract, less amounts held in the funds commodity brokerage account at its broker. At any time prior to the expiration of a futures contract, the fund may elect to close the position by taking
an opposite position, which will operate to terminate the funds existing position in the contract.
Positions in futures
contracts may be closed out only on the exchange on which they were entered into (or through a linked exchange) and no secondary market exists for those contracts. In addition, there is no assurance that an active market will exist for the contracts
at any particular time. Most futures exchanges and boards of trade limit the amount of fluctuation permitted in futures contract prices during a single trading day. Once the daily limit has been reached in a particular contract, no trades may be
made that day at a price beyond that limit.
It is possible that futures contract prices could move to the daily limit for
several consecutive trading days with little or no trading, thereby preventing prompt liquidation of futures positions and subjecting some futures traders to substantial losses. In such event, and in the event of adverse price movements, the fund
would be required to make daily cash payments of variation margin; in such circumstances, an increase in the value of the
22
portion of the portfolio being hedged, if any, may partially or completely offset losses on the futures contract. As described above, however, no assurance can be given that the price of the
securities being hedged will correlate with the price movements in a futures contract and thus provide an offset to losses on the futures contract.
Options on futures contracts are similar to options on securities or currencies except that options on futures contracts give the purchaser the right, in return for the premium paid, to assume a position
in a futures contract (a long position if the option is a call and a short position if the option is a put), rather than to purchase or sell the futures contract, at a specified exercise price at any time during the period of the option. Upon
exercise of the option, the delivery of the futures position by the writer of the option to the holder of the option will be accompanied by delivery of the accumulated balance in the writers futures margin account, which represents the amount
by which the market price of the futures contract, at exercise, exceeds (in the case of a call) or is less than (in the case of a put) the exercise price of the option on the futures contract. If an option is exercised on the last trading day prior
to the expiration date of the option, the settlement will be made entirely in cash equal to the difference between the exercise price of the option and the closing level of the securities or currencies upon which the futures contracts are based on
the expiration date. Purchasers of options who fail to exercise their options prior to the exercise date suffer a loss of the premium paid.
Margin Requirements.
In contrast to the purchase or sale of a security, no price is paid or received upon the purchase or sale of a futures contract. Initially, the fund will be required to deposit
with the broker an amount of cash or cash equivalents equal to approximately 1% to 10% of the contract amount (this amount is subject to change by the exchange or board of trade on which the contract is traded and brokers or members of such board of
trade may charge a higher amount). This amount is known as initial margin and is in the nature of a performance bond or good faith deposit on the contract, which is returned to the fund, upon termination of the futures contract, assuming
all contractual obligations have been satisfied. Subsequent payments, known as variation margin, to and from the broker, will be made daily as the price of the index or securities underlying the futures contract fluctuates, making the
long and short positions in the futures contract more or less valuable, a process known as marking-to-market. In addition, when the fund enters into a long position in a futures contract, it must maintain an amount of cash or cash
equivalents equal to the total market value of the underlying futures contract, less amounts held in the funds commodity brokerage account at its broker. At any time prior to the expiration of a futures contract, the fund may elect to close
the position by taking an opposite position, which will operate to terminate the funds existing position in the contract.
For example, when the fund purchases a futures contract and the price of the underlying security or index rises, that position increases
in value, and the fund receives from the broker a variation margin payment equal to that increase in value. Conversely, where the fund purchases a futures contract and the value of the underlying security or index declines, the position is less
valuable, and the fund is required to make a variation margin payment to the broker.
At any time prior to expiration of the
futures contract, the fund may elect to terminate the position by taking an opposite position. A final determination of variation margin is then made, additional cash is required to be paid by or released to the fund, and the fund realizes a loss or
a gain.
When the fund anticipates a significant market or market sector advance, the purchase of a futures contract affords a
hedge against not participating in the advance (anticipatory hedge). Such purchase of a futures contract serves as a temporary substitute for the purchase of individual securities, which may be purchased in an orderly fashion once the market has
stabilized. As individual securities are purchased, an equivalent amount of futures contracts could be terminated by offsetting sales. The fund may sell futures contracts in anticipation of or in a general market or market sector decline that may
adversely affect the market value of the funds securities (defensive hedge). To the extent that the funds portfolio of securities changes in value in correlation with the underlying security or index, the sale of futures contracts
substantially reduces the risk to the fund of a market decline and, by so doing, provides an alternative to the liquidation of securities positions in the fund with attendant transaction costs.
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The fund will be required to deposit initial margin and maintenance margin with respect to
put and call options on futures contracts described above, and, in addition, net option premiums received will be included as initial margin deposits.
Use of Segregated and Other Special Accounts.
Use of many hedging and other strategic transactions including market index transactions by the fund will require, among other things, that the fund
segregate cash, liquid securities or other assets with its custodian, or a designated sub-custodian, to the extent the funds obligations are not otherwise covered through ownership of the underlying security or financial
instrument. In general, either the full amount of any obligation by the fund to pay or deliver securities or assets must be covered at all times by the securities or instruments required to be delivered, or, subject to any regulatory restrictions,
appropriate securities as required by the 1940 Act at least equal to the current amount of the obligation must be segregated with the custodian or sub-custodian. The segregated assets cannot be sold or transferred unless equivalent assets are
substituted in their place or it is no longer necessary to segregate them. A call option on securities written by the fund, for example, will require the fund to hold the securities subject to the call (or securities convertible into the needed
securities without additional consideration) or to segregate liquid securities sufficient to purchase and deliver the securities if the call is exercised. A call option written by the fund on an index will require the fund to own portfolio
securities that correlate with the index or to segregate liquid securities equal to the excess of the index value over the exercise price on a current basis. A put option on securities written by the fund will require the fund to segregate liquid
securities equal to the exercise price.
OTC options entered into by the fund, including those on securities, financial
instruments or indexes, and OCC-issued and exchange-listed index options will generally provide for cash settlement, although the fund may not be required to do so. As a result, when the fund sells these instruments it will segregate an amount of
assets equal to its obligations under the options. OCC-issued and exchange-listed options sold by the fund other than those described above generally settle with physical delivery, and the fund will segregate an amount of assets equal to the full
value of the option. OTC options settling with physical delivery or with an election of either physical delivery or cash settlement will be treated the same as other options settling with physical delivery. If the fund enters into OTC options
transactions, it will be subject to counterparty risk.
In the case of a futures contract or an option on a futures contract,
the fund must deposit initial margin and, in some instances, daily variation margin, typically with third parties such as a clearing organization, in addition to segregating assets with its custodian sufficient to meet its obligations to purchase or
provide securities, or to pay the amount owed at the expiration of an index-based futures contract. These assets may consist of cash, cash equivalents, liquid securities or other acceptable assets.
Hedging and other strategic transactions may be covered by means other than those described above when consistent with applicable
regulatory policies. The fund may also enter into offsetting transactions so that its combined position, coupled with any segregated assets, equals its net outstanding obligation in related options and hedging and other strategic transactions. The
fund could purchase a put option, for example, if the strike price of that option is the same or higher than the strike price of a put option sold by the fund. Moreover, instead of segregating assets if it holds a futures contract or forward
contract, the fund could purchase a put option on the same futures contract or forward contract with a strike price as high or higher than the price of the contract held. Other hedging and other strategic transactions may also be offset in
combinations. If the offsetting transaction terminates at the time of or after the primary transaction, no segregation is required, but if it terminates prior to that time, assets equal to any remaining obligation would need to be segregated.
Special Risks of Using Futures Contracts.
The prices of futures contracts are volatile and are influenced by, among
other things, actual and anticipated changes in stock market prices or interest rates, which in turn are affected by fiscal and monetary policies and national and international political and economic events.
At best, the correlation between changes in prices of futures contracts and of the securities being hedged can be only approximate. The
degree of imperfection of correlation depends upon circumstances such as: variations
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in speculative market demand for futures and for equity securities or debt securities, including technical influences in futures trading; and differences between the financial instruments being
hedged and the instruments underlying the standard futures contracts available for trading, with respect to market values, interest rate levels, maturities, and creditworthiness of issuers. A decision of whether, when, and how to hedge involves
skill and judgment, and even a well-conceived hedge may be unsuccessful to some degree because of unexpected market behavior or interest rate trends.
Because of the low margin deposits required, futures trading involves an extremely high degree of leverage. As a result, a relatively small price movement in a futures contract may result in immediate and
substantial loss as well as gain to the investor.
Furthermore, in the case of a futures contract purchase, in order to be
certain that the fund has sufficient assets to satisfy its obligations under a futures contract, the fund segregates and commits to back the futures contract with an amount of cash and liquid securities from the fund equal in value to the current
value of the underlying instrument less the margin deposit.
Most U.S. futures exchanges limit the amount of fluctuation
permitted in futures contract prices during a single trading day. The daily limit establishes the maximum amount that the price of a futures contract may vary either up or down from the previous days settlement price at the end of a trading
session. Once the daily limit has been reached in a particular type of futures contract, no trades may be made on that day at a price beyond that limit. The daily limit governs only price movement during a particular trading day and, therefore, does
not limit potential losses, because the limit may prevent the liquidation of unfavorable positions. Futures contract prices have occasionally moved to the daily limit for several consecutive trading days with little or no trading, thereby preventing
prompt liquidation of futures positions and subjecting some futures traders to substantial losses.
As with options on
securities, the holder of an option on futures contracts may terminate the position by selling an option of the same series. There is no guarantee that such closing transactions can be effected. The fund will be required to deposit initial margin
and maintenance margin with respect to put and call options on futures contracts described above, and, in addition, net option premiums received will be included as initial margin deposits.
In addition to the risks which apply to all option transactions, there are several special risks relating to options on futures
contracts. The ability to establish and close out positions on such options will be subject to the development and maintenance of a liquid secondary market. It is not certain that this market will develop. The fund will not purchase options on
futures contracts on any exchange unless and until, in the subadvisers opinion, the market for such options has developed sufficiently that the risks in connection with options on futures contracts are not greater than the risks in connection
with futures contracts. Compared to the use of futures contracts, the purchase of options on futures contracts involves less potential risk to the fund because the maximum amount of risk is the premium paid for the options (plus transaction costs).
Writing an option on a futures contract involves risks similar to those arising in the sale of futures contracts, as described above.
Special Risks of Writing Options.
Option writing for the fund may be limited by position and exercise limits established by national securities exchanges and by requirements of the Code for
qualification as a regulated investment company. In addition to writing covered call options to generate current income, the fund may enter into options transactions as hedges to reduce investment risk, generally by making an investment expected to
move in the opposite direction of a portfolio position. A hedge is designed to offset a loss on a portfolio position with a gain on the hedge position; at the same time, however, a properly correlated hedge will result in a gain on the portfolio
position being offset by a loss on the hedge position. The fund bears the risk that the prices of the securities being hedged will not move in the same amount as the hedge. The fund will engage in hedging transactions only when deemed advisable by
the subadviser. Successful use by the fund of options will be subject to the subadvisers ability to predict correctly movements in the direction of the stock or index underlying the option used as a hedge. Losses incurred in hedging
transactions and the costs of these transactions will affect the funds performance.
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The ability of the fund to engage in closing transactions with respect to options depends on
the existence of a liquid secondary market. While the fund generally will write options only if a liquid secondary market appears to exist for the options purchased or sold, for some options no such secondary market may exist or the market may cease
to exist. If the fund cannot enter into a closing purchase transaction with respect to a call option it has written, the fund will continue to be subject to the risk that its potential loss upon exercise of the option will increase as a result of
any increase in the value of the underlying security. The fund could also face higher transaction costs, including brokerage commissions, as a result of its options transactions.
Swaps, Caps, Floors and Collars.
The fund may enter into swaps, caps, floors and collars to preserve a return or a spread on a
particular investment or portion of its portfolio, to protect against any increase in the price of securities the fund anticipates purchasing at a later date or to attempt to enhance yield or total return. A swap typically involves the exchange by
the fund with another party of their respective commitments to pay or receive cash flows, e.g., an exchange of floating rate payments for fixed-rate payments. The purchase of a cap entitles the purchaser, to the extent that a specified index exceeds
a predetermined value, to receive payments on a notional principal amount from the party selling the cap. The purchase of a floor entitles the purchaser, to the extent that a specified index falls below a predetermined value, to receive payments on
a notional principal amount from the party selling the floor. A collar combines elements of a cap and a floor.
Swap
agreements, including caps, floors and collars, can be individually negotiated and structured to include exposure to a variety of different types of investments (such as individual securities, baskets of securities and securities indices) or market
factors (such as those listed below). Depending on their structure, swap agreements may increase or decrease the overall volatility of the funds investments and its share price and yield because, and to the extent, these agreements affect the
funds exposure to long- or short-term interest rates, non-U.S. currency values, mortgage-backed or other security values, corporate borrowing rates or other factors such as security prices or inflation rates.
Swap agreements will tend to shift the funds investment exposure from one type of investment to another. Caps and floors have an
effect similar to buying or writing options.
If a counterpartys creditworthiness declines, the value of the agreement
would be likely to decline, potentially resulting in losses.
The fund may enter into credit default swap contracts for
investment purposes. As the seller in a credit default swap contract, the fund would be required to pay the par (or other agreed-upon) value of a referenced debt obligation to the counterparty in the event of a default by a third party, such as a
U.S. or a non- U.S. corporate issuer, on the debt obligation. In return, the fund would receive from the counterparty a periodic stream of payments over the term of the contract provided that no event of default has occurred. If no default occurs,
the fund would keep the stream of payments and would have no payment obligations. As the seller, the fund would be subject to investment exposure on the notional amount of the swap which may be significantly larger than the funds cost to enter
into the credit default swap. The fund may also invest in credit default indices, which are indices that reflect the performance of a basket of credit default swaps, and swaptions on credit default swap indices. (See Options on Swaps
below.)
The fund may purchase credit default swap contracts in order to hedge against the risk of default of debt securities
held in its portfolio, in which case the fund would function as the counterparty referenced in the preceding paragraph. This would involve the risk that the investment may expire worthless and would only generate income in the event of an actual
default by the issuer of the underlying obligation (or, as applicable, a credit downgrade or other indication of financial instability). It would also involve credit riskthat the seller may fail to satisfy its payment obligations to the fund
in the event of a default.
The fund may enter into an interest rate swap in an effort to protect against declines in the
value of fixed income securities held by the fund. In such an instance, the fund may agree to pay a fixed rate (multiplied by a
26
notional amount) while a counterparty agrees to pay a floating rate (multiplied by the same notional amount). If interest rates rise, resulting in a diminution in the value of the funds
portfolio, the fund would receive payments under the swap that would offset, in whole or in part, such diminution in value.
The net amount of
the excess, if any, of the funds obligations over its entitlements with respect to each swap will be accrued on a daily basis, depending on whether a threshold amount (if any) is exceeded, and an amount of cash or liquid assets having an
aggregate net asset value approximately equal to the accrued excess will be set aside as cover, as described below. The fund will also maintain collateral with respect to its total obligations under any swaps that are not entered into on a net
basis, and will maintain cover as required by SEC guidelines from time to time with respect to caps and floors written by the fund.
Options on Swaps.
An option on a swap agreement, or a swaption, is a contract that gives a counterparty the right (but not the obligation) to enter into a new swap agreement or to
shorten, extend, cancel or otherwise modify an existing swap agreement, at some designated future time on specified terms. In return, the purchaser pays a premium to the seller of the contract. The seller of the contract receives the
premium and bears the risk of unfavorable changes on the underlying swap. The fund may write (sell) and purchase put and call swaptions. The fund may also enter into swaptions on either an asset-based or liability-based basis, depending on whether
the fund is hedging its assets or its liabilities. The fund may write (sell) and purchase put and call swaptions to the same extent it may make use of standard options on securities or other instruments. The fund may enter into these transactions
primarily to preserve a return or spread on a particular investment or portion of its holdings, as a duration management technique, or to protect against an increase in the price of securities the fund anticipates purchasing at a later date or for
any other purposes, such as for speculation to increase returns. Swaptions are generally subject to the same risks involved in the funds use of options.
Depending on the terms of the particular option agreement, the fund will generally incur a greater degree of risk when it writes a swaption than it will incur when it purchases a swaption. When the fund
purchases a swaption, it risks losing only the amount of the premium it has paid should it decide to let the option expire unexercised. However, when the fund writes a swaption, upon exercise of the option the fund will become obligated according to
the terms of the underlying agreement.
Restricted and Illiquid Securities.
Up to 15% of the net assets of the fund may
be invested in illiquid securities. An illiquid security is any security which may not be sold or disposed of in the ordinary course of business within seven days at approximately the value at which the fund has valued the security. Illiquid
securities may include (a) repurchase agreements with maturities greater than seven days; (b) futures contracts and options thereon for which a liquid secondary market does not exist; (c) TDs maturing in more than seven calendar days;
(d) securities subject to contractual or other restrictions on resale and other instruments that lack readily available markets; and (e) securities of new and early stage companies whose securities are not publicly traded.
Under SEC regulations, certain securities acquired through private placements can be traded freely among qualified purchasers. The SEC
has stated that an investment companys board of directors, or its investment adviser acting under authority delegated by the board, may determine that a security eligible for trading under these regulations is liquid. The fund
intends to rely on these regulations, to the extent appropriate, to deem specific securities acquired through private placements as liquid. The Board has delegated to the subadviser or Western Asset, as applicable, the responsibility for
determining whether a particular security eligible for trading under these regulations is liquid. Investing in these restricted securities could have the effect of increasing the funds illiquidity if qualified purchasers become,
for a time, uninterested in buying these securities.
Restricted securities are securities subject to legal or contractual
restrictions on their resale, such as private placements. Such restrictions might prevent the sale of restricted securities at a time when the sale would otherwise be desirable. Restricted securities may be sold only (1) pursuant to Rule 144A
under the Securities Act of 1933, as amended (the 1933 Act) (such securities are referred to herein as Rule 144A securities), or
27
another exemption; (2) in privately negotiated transactions; or (3) in public offerings with respect to which a registration statement is in effect under the 1933 Act. Rule 144A
securities, although not registered in the United States, may be sold to qualified institutional buyers in accordance with Rule 144A under the 1933 Act. As noted above, the subadviser or Western Asset, as applicable, acting pursuant to
guidelines established by the Board, may determine that some Rule 144A securities are liquid for purposes of limitations on the amount of illiquid investments the fund may own. Where registration is required, the fund may be obligated to pay all or
part of the registration expenses and a considerable period may elapse between the time of the decision to sell and the time the fund is able to sell a security under an effective registration statement. If, during such a period, adverse market
conditions were to develop, the fund might obtain a less favorable price than expected when it decided to sell.
Illiquid
securities may be difficult to value and the fund may have difficulty disposing of such securities promptly. Judgment plays a greater role in valuing illiquid investments than those securities for which a more active market exists. The fund does not
consider non-U.S. securities to be restricted if they can be freely sold in the principal markets in which they are traded, even if they are not registered for sale in the United States.
To the extent required by applicable law and SEC guidance, no securities for which there is not a readily available market will be
acquired by the fund if such acquisition would cause the aggregate value of illiquid securities to exceed 15% of the funds net assets.
Securities of Unseasoned Issuers.
Securities in which the fund may invest may have limited marketability and, therefore, may be subject to wide fluctuations in market value. In addition, certain
securities may be issued by companies that lack a significant operating history and be dependent on products or services without an established market share.
Repurchase Agreements.
The fund may agree to purchase securities from a bank or recognized securities dealer and simultaneously commit to resell the securities to the bank or dealer at an
agreed-upon date and price reflecting a market rate of interest unrelated to the coupon rate or maturity of the purchased securities (repurchase agreements). Under the terms of a typical repurchase agreement, the fund would acquire an
underlying debt obligation for a relatively short period (usually not more than one week) subject to an obligation of the seller to repurchase, and the fund to resell, the obligation at an agreed-upon price and time, thereby determining the yield
during the funds holding period. If the value of such securities were less than the repurchase price, plus interest, the other party to the agreement would be required to provide additional collateral so that at all times the collateral is at
least 102% of the repurchase price plus accrued interest. The financial institutions with which the fund may enter into repurchase agreements will be banks and non-bank dealers of U.S. government securities that are on the Federal Reserve Bank of
New Yorks list of reporting dealers, if such banks and non-bank dealers are deemed creditworthy by the subadviser. Repurchase agreements could involve certain risks in the event of default or insolvency of the other party, including possible
delays or restrictions upon the funds ability to dispose of the underlying securities, the risk of a possible decline in the value of the underlying securities during the period in which the fund seeks to assert its right to them, the risk of
incurring expenses associated with asserting those rights and the risk of losing all or part of the income from the agreement. Western Asset, acting under the supervision of the Board, reviews on an ongoing basis the value of the collateral and
creditworthiness of those banks and dealers with which the fund enters into repurchase agreements to evaluate potential risks.
Pursuant to an exemptive order issued by the SEC, the fund, along with other affiliated entities managed by the manager or its
affiliates, may transfer uninvested cash balances into one or more joint repurchase accounts. These balances are invested in one or more repurchase agreements, secured by U.S. government securities. Each joint repurchase arrangement requires that
the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default by the other party to the agreement, retention or sale of the collateral may be subject to legal proceedings.
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Reverse Repurchase Agreements.
The fund may enter into reverse repurchase agreements,
which involve the sale of fund securities with an agreement to repurchase the securities at an agreed-upon price, date and interest payment and have the characteristics of borrowings. Since the proceeds of borrowings under reverse repurchase
agreements are invested, this would introduce the speculative factor known as leverage. The securities purchased with the funds obtained from the agreement and securities collateralizing the agreement will have maturity dates no later
than the repayment date. Generally the effect of such a transaction is that the fund can recover all or most of the cash invested in the portfolio securities involved during the term of the reverse repurchase agreement, while in many cases it will
be able to keep some of the interest income associated with those securities. Such transactions are advantageous only if the fund has an opportunity to earn a greater rate of interest on the cash derived from the transaction than the interest cost
of obtaining that cash. Opportunities to realize earnings from the use of the proceeds equal to or greater than the interest required to be paid may not always be available, and the fund intends to use the reverse repurchase technique only when
Western Asset believes it will be advantageous to the fund. The use of reverse repurchase agreements may exaggerate any interim increase or decrease in the value of the funds assets. The funds custodian bank will maintain a separate
account for the fund with securities having a value equal to or greater than such commitment of the fund.
Investments by
Funds of Funds.
Certain investment companies, including those that are affiliated with the fund because they are managed by an affiliate of the manager, may invest in the fund as part of an asset allocation strategy. These investment companies
are referred to as funds of funds because they invest primarily in other investment companies.
From time to time,
the fund may experience relatively large redemptions or investments due to rebalancings of the assets of a fund of funds invested in the fund. In the event of such redemptions or investments, the fund could be required to sell securities or to
invest cash at a time when it is not advantageous to do so. If this were to occur, the effects of the rebalancing trades could adversely affect the funds performance. Redemptions of fund shares due to rebalancings could also accelerate the
realization of taxable capital gains in the fund and might increase brokerage and/or other transaction costs.
The funds
subadviser may be subject to potential conflicts of interest in connection with investments by affiliated funds of funds. For example, the subadviser may have an incentive to permit an affiliated fund of funds to become a more significant
shareholder (with the potential to cause greater disruption to the funds) than would be permitted for an unaffiliated investor. The subadviser has committed to the Board that it will resolve any potential conflict in the best interests of the
shareholders of the fund in accordance with its fiduciary duty to the fund. As necessary, the subadviser will take such actions as it deems appropriate to minimize potential adverse impacts, including redemption of shares in-kind, rather than in
cash. Similar issues may result from investment in the fund by Section 529 plans.
Short Sales
. The fund may sell
securities short. A short sale is effected when it is believed that the price of a particular security will decline, and involves the sale of a security which the fund does not own in the hope of purchasing the same security at a later date at a
lower price. There can be no assurance that the fund will be able to close out a short position (
i.e.
, purchase the same security) at any particular time or at an acceptable or advantageous price. To make delivery to the buyer, the fund must
borrow the security from a broker/dealer through which the short sale is executed, and the broker/dealer must deliver the security, on behalf of the fund, to the buyer. The broker/dealer is entitled to retain the proceeds from the short sale until
the fund delivers to such broker/dealer the security sold short. In addition, the fund is required to pay to the broker/dealer the amount of any dividends or interest paid on shares sold short.
The fund will realize a gain if the price of a security declines between the date of the short sale and the date on which the fund
purchases a security to replace the borrowed security. On the other hand, the fund will incur a loss if the price of the security increases between those dates. The amount of any gain will be decreased and the amount of any loss increased by any
premium or interest that the fund may be required to pay in connection with a short sale. Short selling is a technique that may be considered speculative and involves risks beyond the initial
29
capital necessary to secure each transaction. Generally, the fund may not keep, and must return to the lender, any dividends or interest that accrue on the borrowed security during the period of
the loan. Depending on the arrangements with a broker or the custodian, the fund may or may not receive any payments (including interest) on collateral it designates as security for the broker. It should be noted that possible losses from short
sales differ from those losses that could arise from a cash investment in a security because losses from a short sale may be limitless, while the losses from a cash investment in a security cannot exceed the total amount of the investment in the
security. Whenever the fund sells short, it must segregate assets held by its custodian as collateral to cover its obligation, and maintain the collateral in an amount at least equal to the market value of the short position. To the extent that the
liquid securities segregated by the funds custodian are subject to gain or loss, and the securities sold short are subject to the possibility of gain or loss, leverage is created. The liquid securities utilized by the fund in this respect will
normally be primarily composed of equity portfolio securities that are subject to gains or losses and, accordingly, when the fund executes short sales leverage will normally be created.
There is also a risk that a borrowed security will need to be returned to the broker/dealer on short notice. If the request for the
return of a security occurs at a time when other short sellers of the security are receiving similar requests, a short squeeze can occur, meaning that the fund might be compelled, at the most disadvantageous time, to replace the borrowed
security with a security purchased on the open market, possibly at prices significantly in excess of the proceeds received earlier.
The fund has a short position in the securities sold short until it delivers to the broker/dealer the securities sold, at which time the fund receives the proceeds of the sale. The fund will normally
close out a short position by purchasing on the open market and delivering to the broker/dealer an equal amount of the securities sold short.
As a hedging technique, the fund may purchase call options to buy securities sold short by the fund. Such options would lock in a future price and protect the fund in case of an unanticipated increase in
the price of a security sold short by the fund.
Short Sales Against the Box.
The fund may also make short sales
against the box, meaning that at all times when a short position is open, the fund owns an equal amount of such securities or securities convertible into or exchangeable, without payment of further consideration, for securities of the
same issues as, and in an amount equal to, the securities sold short. Short sales against the box result in a constructive sale and require the fund to recognize any gain unless an exception to the constructive sale rule
applies.
Exchange-Traded Funds (ETFs).
The fund invests in shares of ETFs whose shares are listed and
traded on U.S. stock exchanges or otherwise traded in the OTC market. As with other investments in shares of mutual funds, the fund will bear its pro rata portion of the ETFs expenses, including advisory fees, brokerage, shareholder servicing
and other operational expenses. These expenses are in addition to the direct expenses of the funds own operations.
ETFs
are ownership interests in investment companies, unit investment trusts, depositary receipts and other pooled investment vehicles that are traded on an exchange and that hold a portfolio of securities or other financial instruments (the
Underlying Assets). The Underlying Assets are typically selected to correspond to the securities that comprise a particular broad based, sector or international index, or to provide exposure to a particular industry sector or asset
class, including precious metals or other commodities. Many ETFs are not actively managed. Therefore, those ETFs may not sell a security because the securitys issuer was in financial difficulty unless that security is removed from
the relevant index. Such an ETF may not perform the same as its benchmark index due to tracking error. An ETFs return may not match the return of the benchmark index for a number of reasons. For example, the ETF incurs a number of operating
expenses not applicable to the benchmark index, and incurs costs in buying and selling securities, especially when rebalancing the ETFs securities holdings to reflect changes in the composition of the benchmark index, or a representative
sample of the benchmark index. The ETF may not be fully invested at times, either as a result of cash flows into the ETF or
30
reserves of cash held by the ETF to meet redemptions and pay expenses. Since the ETF may utilize a sampling approach and may hold futures or other derivative positions, its return may not
correlate as well with the return on the benchmark index, as would be the case if the ETF purchased all of the stocks in the benchmark index. Such an ETF would be subject to management risk, which is the risk that the ETFs advisers
security selection process may not produce the intended results. Short ETFs seek a return similar to the inverse, or a multiple of the inverse, of a reference index. Short ETFs carry additional risks because their Underlying Assets may
include a variety of financial instruments, including futures and options on futures, options on securities and securities indexes, swap agreements and forward contracts, and they may engage in short sales. An ETFs losses on short sales are
potentially unlimited; however, the funds risk would be limited to the amount it invested in the ETF.
Unlike shares of
typical mutual funds or unit investment trusts, shares of ETFs are designed to be traded throughout the trading day, bought and sold based on market prices rather than NAV. Shares can trade at either a premium or discount to NAV. The portfolios held
by ETFs are publicly disclosed on each trading day and an approximation of actual NAV is disseminated throughout the trading day. Because of this transparency, the trading prices of ETFs tend to closely track the actual NAV of the Underlying Assets
and the fund will generally gain or lose value depending on the performance of the Underlying Assets. In the future, as new products become available, the fund may invest in ETFs that do not have this same level of transparency and, therefore, may
be more likely to trade at a larger discount or premium to actual NAVs. Gains or losses on the funds investments in ETFs will ultimately depend on the purchase and sale price of the ETF. An active trading market for an ETFs shares may
not develop or be maintained and trading of an ETFs shares may be halted if the listing exchanges officials deem such action appropriate, the shares are delisted from the exchange or the activation of market-wide circuit
breakers (which are tied to large decreases in stock prices) halts stock trading generally.
An investment in an ETF
involves risks similar to investing directly in the Underlying Assets, including the risk that the value of the Underlying Assets may fluctuate in accordance with changes in the financial condition of their issuers, the value of securities and other
financial instruments generally, and other market factors.
The performance of an ETF will be reduced by transaction and other
expenses, including fees paid by the ETF to service providers. Investors in ETFs are eligible to receive their portion of income, if any, accumulated on the securities held in the portfolio, less fees and expenses of the ETF.
ETFs that invest in commodities may be or may become subject to CFTC trading regulations that limit the amount of commodity contracts an
ETF may hold. Such regulations could hurt the value of such ETFs securities. Additionally, some commodity ETFs invest in commodity futures which can lose money even when commodity prices are rising (see Commodity-Linked Derivative
Instruments above).
If an ETF is a registered investment company (as defined in the 1940 Act), the limitations
applicable to the funds ability to purchase securities issued by other investment companies apply. However, the SEC has granted orders for exemptive relief to certain ETFs that permit investments in those ETFs by other investment companies in
excess of these limits. The SEC has issued such exemptive orders to certain ETFs in which the fund may invest, which permits investment companies to invest in such ETFs beyond the limitations in the 1940 Act, subject to certain terms and conditions.
Under the orders, the fund generally may acquire up to 25% of the assets of an ETF. Some ETFs are not structured as investment companies and thus are not regulated under the 1940 Act.
Exchange-Traded Notes (ETNs).
The fund may invest in ETNs. ETNs are senior, unsecured, unsubordinated debt securities
whose returns are linked to the performance of a particular market benchmark or strategy minus applicable fees. ETNs are publicly traded on a U.S. securities exchange. However, investors can also hold the ETN until maturity. At maturity, the issuer
pays to the investor a cash amount equal to the principal amount, subject to the days market benchmark or strategy factor.
ETNs do not make periodic coupon payments or provide principal protection. ETNs are subject to credit risk and the value of the ETN may drop due to a downgrade in the issuers credit rating, despite
the underlying
31
market benchmark or strategy remaining unchanged. The value of an ETN may also be influenced by time to maturity, level of supply and demand for the ETN, volatility and lack of liquidity in
underlying assets, changes in the applicable interest rates, changes in the issuers credit rating, and economic, legal, political or geographic events that affect the referenced underlying asset. When the fund invests in ETNs it will bear its
proportionate share of any fees and expenses borne by the ETN. These fees and expenses generally reduce the return realized at maturity or upon redemption from an investment in an ETN; therefore, the value of the index underlying the ETN must
increase significantly in order for an investor in an ETN to receive at least the principal amount of the investment at maturity or upon redemption. The funds decision to sell its ETN holdings may be limited by the availability of a secondary
market. ETNs are also subject to tax risk. The Internal Revenue Service (the IRS) and Congress have in the past considered proposals that would change the timing and character of income and gains from ETNs. There may be times when an ETN
share trades at a premium or discount to its NAV.
Equity-Linked Notes.
Equity-linked notes (ELNs) are
securities that are valued based upon the performance of one or more equity securities, such as a stock index, a group of stocks or a single stock. ELNs offer investors the opportunity to participate in the appreciation of the underlying local
equity securities where the fund may not have established local access. Investors in ELNs are subject to risk of loss of principal investment.
INVESTMENT POLICIES
The fund has adopted the
fundamental and non-fundamental investment policies below for the protection of shareholders. Fundamental investment policies of the fund may not be changed without the vote of a majority of the outstanding shares of the fund, defined under the 1940
Act as the lesser of (a) 67% or more of the voting power of the fund present at a shareholder meeting, if the holders of more than 50% of the voting power of the fund are present in person or represented by proxy, or (b) more than 50% of
the voting power of the fund. The Board may change non-fundamental investment policies at any time.
If any percentage
restriction described below is complied with at the time of an investment, a later increase or decrease in the percentage resulting from a change in values or assets will not constitute a violation of such restriction.
Fundamental Investment Policies
The funds fundamental investment policies are as follows:
(1) The fund may not borrow money except as permitted by (i) the 1940 Act or interpretations or modifications by the
SEC, SEC staff or other authority with appropriate jurisdiction, or (ii) exemptive or other relief or permission from the SEC, SEC staff or other authority.
(2) The fund may not engage in the business of underwriting the securities of other issuers except as permitted by
(i) the 1940 Act or interpretations or modifications by the SEC, SEC staff or other authority with appropriate jurisdiction, or (ii) exemptive or other relief or permission from the SEC, SEC staff or other authority.
(3) The fund may lend money or other assets to the extent permitted by (i) the 1940 Act or interpretations or
modifications by the SEC, SEC staff or other authority with appropriate jurisdiction, or (ii) exemptive or other relief or permission from the SEC, SEC staff or other authority.
(4) The fund may not issue senior securities except as permitted by (i) the 1940 Act or interpretations or
modifications by the SEC, SEC staff or other authority with appropriate jurisdiction, or (ii) exemptive or other relief or permission from the SEC, SEC staff or other authority.
(5) The fund may not purchase or sell real estate except as permitted by (i) the 1940 Act or interpretations or
modifications by the SEC, SEC staff or other authority with appropriate jurisdiction, or (ii) exemptive or other relief or permission from the SEC, SEC staff or other authority.
32
(6) The fund may purchase or sell commodities or contracts related to
commodities to the extent permitted by (i) the 1940 Act or interpretations or modifications by the SEC, SEC staff or other authority with appropriate jurisdiction, or (ii) exemptive or other relief or permission from the SEC, SEC staff or
other authority.
(7) Except as permitted by exemptive or other relief or permission from the SEC, SEC staff or
other authority with appropriate jurisdiction, the fund may not make any investment if, as a result, the funds investments will be concentrated in any one industry.
With respect to the fundamental policy relating to borrowing money set forth in (1) above, the 1940 Act permits the fund to borrow money in amounts of up to one-third of the funds total assets
from banks for any purpose, and to borrow up to 5% of the funds total assets from banks or other lenders for temporary purposes. (The funds total assets include the amounts being borrowed.) To limit the risks attendant to borrowing, the
1940 Act requires the fund to maintain at all times an asset coverage of at least 300% of the amount of its borrowings. Asset coverage means the ratio that the value of the funds total assets (including amounts borrowed),
minus liabilities other than borrowings, bears to the aggregate amount of all borrowings. Certain trading practices and investments, such as reverse repurchase agreements, may be considered to be borrowings and thus subject to the 1940 Act
restrictions. Borrowing money to increase portfolio holdings is known as leveraging. Borrowing, especially when used for leverage, may cause the value of the funds shares to be more volatile than if the fund did not borrow. This is
because borrowing tends to magnify the effect of any increase or decrease in the value of the funds portfolio holdings. Borrowed money thus creates an opportunity for greater gains, but also greater losses. To repay borrowings, the fund may
have to sell securities at a time and at a price that is unfavorable to the fund. There also are costs associated with borrowing money, and these costs would offset and could eliminate the funds net investment income in any given period.
Currently, the fund has no intention of borrowing money for leverage but if the fund does so, it will likely not do so to a substantial degree. The policy in (1) above will be interpreted to permit the fund to engage in trading practices and
investments that may be considered to be borrowing to the extent permitted by the 1940 Act. Short-term credits necessary for the settlement of securities transactions and arrangements with respect to securities lending will not be considered to be
borrowings under the policy. Practices and investments that may involve leverage but are not considered to be borrowings are not subject to the policy.
With respect to the fundamental policy relating to underwriting set forth in (2) above, the 1940 Act does not prohibit the fund from engaging in the underwriting business or from underwriting the
securities of other issuers; in fact, the 1940 Act permits the fund to have underwriting commitments of up to 25% of its assets under certain circumstances. Those circumstances currently are that the amount of the funds underwriting
commitments, when added to the value of the funds investments in issuers where the fund owns more than 10% of the outstanding voting securities of those issuers, cannot exceed the 25% cap. A fund engaging in transactions involving the
acquisition or disposition of portfolio securities may be considered to be an underwriter under the 1933 Act. Under the 1933 Act, an underwriter may be liable for material omissions or misstatements in an issuers registration statement or
prospectus. Securities purchased from an issuer and not registered for sale under the 1933 Act are considered restricted securities. There may be a limited market for these securities. If these securities are registered under the 1933 Act, they may
then be eligible for sale but participating in the sale may subject the seller to underwriter liability. These risks could apply to a fund investing in restricted securities. Although it is not believed that the application of the 1933 Act
provisions described above would cause the fund to be engaged in the business of underwriting, the policy in (2) above will be interpreted not to prevent the fund from engaging in transactions involving the acquisition or disposition of
portfolio securities, regardless of whether the fund may be considered to be an underwriter under the 1933 Act.
With respect
to the fundamental policy relating to lending set forth in (3) above, the 1940 Act does not prohibit the fund from making loans; however, SEC staff interpretations currently prohibit funds from lending more than one-third of their total assets,
except through the purchase of debt obligations or the use of repurchase agreements. (A repurchase agreement is an agreement to purchase a security, coupled with an agreement to sell
33
that security back to the original seller on an agreed-upon date at a price that reflects current interest rates. The SEC frequently treats repurchase agreements as loans.) While lending
securities may be a source of income to the fund, as with other extensions of credit, there are risks of delay in recovery or even loss of rights in the underlying securities should the borrower fail financially. However, loans would be made only
when the funds subadviser believes the income justifies the attendant risks. The fund also will be permitted by this policy to make loans of money, including to other funds. The fund would have to obtain exemptive relief from the SEC to make
loans to other funds. The policy in (3) above will be interpreted not to prevent the fund from purchasing or investing in debt obligations and loans. In addition, collateral arrangements with respect to options, forward currency and futures
transactions and other derivative instruments, as well as delays in the settlement of securities transactions, will not be considered loans.
With respect to the fundamental policy relating to issuing senior securities set forth in (4) above, senior securities are defined as fund obligations that have a priority over the
funds shares with respect to the payment of dividends or the distribution of fund assets. The 1940 Act prohibits the fund from issuing senior securities except that the fund may borrow money in amounts of up to one-third of the funds
total assets from banks for any purpose. The fund may also borrow up to 5% of the funds total assets from banks or other lenders for temporary purposes, and these borrowings are not considered senior securities. The issuance of senior
securities by the fund can increase the speculative character of the funds outstanding shares through leveraging. Leveraging of the funds portfolio through the issuance of senior securities magnifies the potential for gain or loss on
monies, because even though the funds net assets remain the same, the total risk to investors is increased to the extent of the funds gross assets. The policy in (4) above will be interpreted not to prevent collateral arrangements
with respect to swaps, options, forward or futures contracts or other derivatives, or the posting of initial or variation margin.
With respect to the fundamental policy relating to real estate set forth in (5) above, the 1940 Act does not prohibit the fund from owning real estate; however, the fund is limited in the amount of
illiquid assets it may purchase. Investing in real estate may involve risks, including that real estate is generally considered illiquid and may be difficult to value and sell. Owners of real estate may be subject to various liabilities, including
environmental liabilities. To the extent that investments in real estate are considered illiquid, the current SEC staff position generally limits the funds purchases of illiquid securities to 15% of net assets. The policy in (5) above
will be interpreted not to prevent the fund from investing in real estate-related companies, companies whose businesses consist in whole or in part of investing in real estate, instruments (like mortgages) that are secured by real estate or
interests therein, or real estate investment trust securities.
With respect to the fundamental policy relating to commodities
set forth in (6) above, the 1940 Act does not prohibit the fund from owning commodities, whether physical commodities and contracts related to physical commodities (such as oil or grains and related futures contracts), or financial commodities
and contracts related to financial commodities (such as currencies and, possibly, currency futures). However, the fund is limited in the amount of illiquid assets it may purchase. To the extent that investments in commodities are considered
illiquid, the current SEC staff position generally limits the funds purchases of illiquid securities to 15% of net assets. If the fund were to invest in a physical commodity or a physical commodity-related instrument, the fund would be subject
to the additional risks of the particular physical commodity and its related market. The value of commodities and commodity-related instruments may be extremely volatile and may be affected either directly or indirectly by a variety of factors.
There may also be storage charges and risks of loss associated with physical commodities. The policy in (6) above will be interpreted to permit investments in ETFs that invest in physical and/or financial commodities.
With respect to the fundamental policy relating to concentration set forth in (7) above, the 1940 Act does not define what
constitutes concentration in an industry. The SEC staff has taken the position that investment of 25% or more of a funds total assets in one or more issuers conducting their principal activities in the same industry or group of
industries constitutes concentration. It is possible that interpretations of concentration could change in the future. A fund that invests a significant percentage of its total assets in a single industry may be
34
particularly susceptible to adverse events affecting that industry and may be more risky than a fund that does not concentrate in an industry. The policy in (7) above will be interpreted to
refer to concentration as that term may be interpreted from time to time. The policy also will be interpreted to permit investment without limit in the following: securities of the U.S. government and its agencies or instrumentalities; securities of
state, territory, possession or municipal governments and their authorities, agencies, instrumentalities or political subdivisions; securities of foreign governments; and repurchase agreements collateralized by any such obligations. Accordingly,
issuers of the foregoing securities will not be considered to be members of any industry. There also will be no limit on investment in issuers domiciled in a single jurisdiction or country. The policy also will be interpreted to give broad authority
to the fund as to how to classify issuers within or among industries.
The funds fundamental policies will be
interpreted broadly. For example, the policies will be interpreted to refer to the 1940 Act and the related rules as they are in effect from time to time, and to interpretations and modifications of or relating to the 1940 Act by the SEC and
others as they are given from time to time. When a policy provides that an investment practice may be conducted as permitted by the 1940 Act, the policy will be interpreted to mean either that the 1940 Act expressly permits the practice or that the
1940 Act does not prohibit the practice.
Non-Fundamental Investment Policies
(1) The fund may not invest in other registered open-end management investment companies and registered unit investment
trusts in reliance upon the provisions of subparagraphs (G) or (F) of Section 12(d)(1) of the 1940 Act. The foregoing investment policy does not restrict the fund from (i) acquiring securities of other registered investment
companies in connection with a merger, consolidation, reorganization, or acquisition of assets, or (ii) purchasing the securities of registered investment companies, to the extent otherwise permissible under Section 12(d)(1) of the 1940
Act.
(2) The fund may not purchase or otherwise acquire any security if, as a result, more than 15% of its net
assets would be invested in securities that are illiquid.
Diversification
The fund is currently classified as a diversified fund under the 1940 Act. This means that the fund may not purchase securities of an
issuer (other than obligations issued or guaranteed by the U.S. government, its agencies or instrumentalities) if, with respect to 75% of its total assets, (a) more than 5% of the funds total assets would be invested in securities of that
issuer or (b) the fund would hold more than 10% of the outstanding voting securities of that issuer. With respect to the remaining 25% of its total assets, the fund can invest more than 5% of its assets in one issuer. Under the 1940 Act, the
fund cannot change its classification from diversified to non-diversified without shareholder approval.
Portfolio Turnover
For reporting purposes, the funds portfolio turnover rate is calculated by dividing the lesser of purchases or sales of portfolio
securities for the fiscal year by the monthly average of the value of the portfolio securities owned by the fund during the fiscal year. In determining such portfolio turnover, all securities whose maturities at the time of acquisition were one year
or less are excluded. A 100% portfolio turnover rate would occur, for example, if all of the securities in the funds investment portfolio (other than short-term money market securities) were replaced once during the fiscal year.
To the extent the portfolio trading results in realization of net short-term capital gains, shareholders will be taxed on such gains at
ordinary tax rates (except shareholders who invest through individual retirement accounts (IRAs) and other retirement plans which are not taxed currently on accumulations in their accounts).
Portfolio turnover will not be a limiting factor should the subadviser or Western Asset deem it advisable to purchase or sell securities.
35
MANAGEMENT
The business and affairs of the fund are conducted by management under the supervision and subject to the direction of its Board. The
business address of each Trustee is c/o R. Jay Gerken, 620 Eighth Avenue, New York, New York 10018. Information pertaining to the Trustees and officers of the fund is set forth below.
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|
|
|
|
|
|
|
|
|
|
|
Name and
Year of Birth
|
|
Position(s)
with Trust
|
|
Term of Office*
and Length of
Time Served**
|
|
Principal Occupation(s)
During Past 5
Years
|
|
Number of
Funds
in Fund
Complex
Overseen
by Trustee
|
|
|
Other Board
Memberships
Held by Trustee
During
Past 5 Years
|
|
|
|
|
|
|
Independent Trustees#:
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|
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|
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|
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Paul R. Ades
Born 1940
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Trustee
|
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Since 1983
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Paul R. Ades, PLLC (law firm) (since 2000)
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49
|
|
|
None
|
|
|
|
|
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|
Andrew L. Breech
Born 1952
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|
Trustee
|
|
Since 1991
|
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President, Dealer Operating Control Service, Inc. (automotive retail management) (since 1985)
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49
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|
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None
|
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|
Dwight B. Crane
Born 1937
|
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Trustee
|
|
Since 1981
|
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Professor Emeritus, Harvard Business School (since 2007); formerly, Professor, Harvard Business School (1969 to 2007); Independent Consultant (since 1969)
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49
|
|
|
None
|
|
|
|
|
|
|
Frank G. Hubbard
Born 1937
|
|
Trustee
|
|
Since 1993
|
|
President, Avatar International Inc. (business development) (since 1998)
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49
|
|
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None
|
|
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|
Howard J. Johnson
Born 1938
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|
Trustee
|
|
From 1981 to 1998 and since 2000
|
|
Chief Executive Officer, Genesis Imaging LLC (technology company) (since 2003)
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49
|
|
|
None
|
|
|
|
|
|
|
Jerome H. Miller
Born 1938
|
|
Trustee
|
|
Since 1995
|
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Retired
|
|
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49
|
|
|
None
|
|
|
|
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|
Ken Miller
Born 1942
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Trustee
|
|
Since 1983
|
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President, Young Stuff Apparel Group, Inc. (apparel manufacturer), division of Li & Fung (since 1963)
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49
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None
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36
|
|
|
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|
|
|
|
|
|
|
|
|
Name and
Year of Birth
|
|
Position(s)
with Trust
|
|
Term of Office*
and Length of
Time Served**
|
|
Principal Occupation(s)
During Past 5
Years
|
|
Number of
Funds
in Fund
Complex
Overseen
by Trustee
|
|
|
Other Board
Memberships
Held by Trustee
During
Past 5 Years
|
|
|
|
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John J. Murphy
Born 1944
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Trustee
|
|
Since 2002
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Founder and Senior Principal, Murphy Capital Management (investment management) (since 1983)
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49
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Trustee, UBS Funds (52 funds) (since 2008); Trustee, Consulting Group Capital Markets Funds (11 funds) (since 2002); formerly, Director, Nicholas Applegate
Institutional Funds (12 funds) (2005 to 2010); formerly, Director, Atlantic Stewardship Bank (2004 to 2005); formerly, Director, Barclays International Funds Group Ltd. and affiliated companies
(1983 to 2003)
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Thomas F. Schlafly
Born 1948
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Trustee
|
|
Since 1983
|
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President, The Saint Louis Brewery, Inc. (brewery) (since 1989); Partner, Thompson Coburn LLP (law firm) (since 2009); formerly, Of Counsel, Husch
Blackwell Sanders LLP (law firm) and its predecessor firms (1984 to 2009)
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49
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Director, Citizens National Bank of Greater St. Louis (since 2006)
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Jerry A. Viscione
Born 1944
|
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Trustee
|
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Since 1993
|
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Retired
|
|
|
49
|
|
|
None
|
37
|
|
|
|
|
|
|
|
|
|
|
|
|
Name and
Year of Birth
|
|
Position(s)
with Trust
|
|
Term of Office*
and Length of
Time Served**
|
|
Principal Occupation(s)
During Past 5
Years
|
|
Number of
Funds
in Fund
Complex
Overseen
by Trustee
|
|
|
Other Board
Memberships
Held by Trustee
During
Past 5 Years
|
|
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Interested Trustee and Officer:
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R. Jay Gerken, CFA
Born 1951
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Trustee, President, Chairman and Chief Executive Officer
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Since 2002
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Managing Director of Legg Mason & Co., LLC (Legg Mason & Co.) (since 2005); Officer and Trustee/Director of 154 funds associated with Legg Mason Partners Fund
Advisor, LLC (LMPFA) or its affiliates (since 2006) and Legg Mason & Co. predecessors (prior to 2006); President and Chief Executive Officer (CEO) of LMPFA (since 2006); President and CEO of Smith Barney Fund Management
LLC (SBFM) (formerly a registered investment adviser) (since 2002)
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154
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None
|
#
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Trustees who are not interested persons of the fund within the meaning of Section 2(a) (19) of the 1940 Act.
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*
|
Each Trustee serves until his respective successor has been duly elected and qualified or until his earlier death, resignation, retirement or removal.
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**
|
Indicates the earliest year in which the Trustee became a board member for a fund in the Legg Mason fund complex.
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Mr. Gerken is an interested person of the fund, as defined in the 1940 Act, because of his position with LMPFA and/or certain of its affiliates.
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|
|
|
|
|
|
|
|
Name, Year of Birth
and Address
|
|
Position(s)
with Trust
|
|
Term of Office*
and Length of
Time Served**
|
|
|
Principal Occupation(s)
During Past 5 Years
|
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|
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|
Additional Officers:
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Ted P. Becker
Born 1951
Legg Mason
620 Eighth Avenue
New York, NY 10018
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Chief
Compliance
Officer
|
|
|
Since 2007
|
|
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Director of Global Compliance at Legg Mason (since 2006); Chief Compliance Officer of LMPFA (since 2006); Managing Director of Compliance of Legg Mason & Co. (since 2005);
Chief Compliance Officer of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2006)
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38
|
|
|
|
|
|
|
|
|
Name, Year of Birth
and Address
|
|
Position(s)
with Trust
|
|
Term of Office*
and Length of
Time Served**
|
|
|
Principal Occupation(s)
During Past 5 Years
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Vanessa Williams
Born 1979
Legg Mason
100 First Stamford Place
Stamford, CT 06902
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Chief Anti-
Money
Laundering
Compliance
Officer
Identity
Theft
Prevention
Officer
|
|
|
Since 2011
Since 2011
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|
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Vice President of Legg Mason & Co. (since 2012); Identity Theft Prevention Officer of certain mutual funds associated with Legg Mason & Co. or its affiliates
(since 2011); Chief Anti-Money Laundering Compliance Officer of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2011); formerly, Senior Compliance Officer of Legg Mason & Co. (2008 to 2011); formerly,
Compliance Analyst of Legg Mason & Co. (2006 to 2008) and Legg Mason & Co. predecessors (prior to 2006)
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Robert I. Frenkel
Born 1954
Legg Mason
100 First Stamford Place
Stamford, CT 06902
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Secretary
and Chief
Legal
Officer
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|
Since 2007
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Vice President and Deputy General Counsel of Legg Mason (since 2006); Managing Director and General Counsel of Global Mutual Funds for Legg Mason & Co. (since 2006) and Legg
Mason & Co. predecessors (since 1994); Secretary and Chief Legal Officer of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2006) and Legg Mason & Co. predecessors (prior to 2006)
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Thomas C. Mandia
Born 1962
Legg Mason
100 First Stamford Place
Stamford, CT 06902
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|
Assistant
Secretary
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|
|
Since 2007
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Managing Director and Deputy General Counsel of Legg Mason & Co. (since 2005) and Legg Mason & Co. predecessors (prior to 2005); Secretary of LMPFA (since 2006);
Assistant Secretary of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2006) and Legg Mason & Co. predecessors (prior to 2006); Secretary of SBFM (since 2002)
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Richard F. Sennett
Born 1970
Legg Mason
100 International Drive
Baltimore, MD 21202
|
|
Principal
Financial
Officer
|
|
|
Since 2011
|
|
|
Principal Financial Officer of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2011); Managing Director of Legg Mason & Co. and Senior
Manager of the Treasury Policy group for Legg Mason & Co.s Global Fiduciary Platform (since 2011); formerly, Chief Accountant within the SECs Division of Investment Management (2007 to 2011); formerly, Assistant Chief Accountant
within the SECs Division of Investment Management (2002 to 2007)
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Albert Laskaj
Born 1977
Legg Mason
55 Water Street
New York, NY 10041
|
|
Treasurer
|
|
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Since 2010
|
|
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Vice President of Legg Mason & Co. (since 2008); Treasurer of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2010); formerly, Controller
of certain mutual funds associated with Legg Mason & Co. or its affiliates (prior to 2010)
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39
|
|
|
|
|
|
|
|
|
Name, Year of Birth
and Address
|
|
Position(s)
with Trust
|
|
Term of Office*
and Length of
Time Served**
|
|
|
Principal Occupation(s)
During Past 5 Years
|
|
|
|
|
Jeanne M. Kelly
Born 1951
Legg Mason
620 Eighth Avenue
New York, NY 10018
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|
Senior
Vice President
|
|
|
Since
2007
|
|
|
Senior Vice President of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2007); Senior Vice President of LMPFA (since 2006); Managing Director
of Legg Mason & Co. (since 2005) and Legg Mason & Co. predecessors (prior to 2005)
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*
|
Each officer serves until his or her respective successor has been duly elected and qualified or until his or her earlier death, resignation, retirement or removal.
|
**
|
Indicates the earliest year in which the officer took such office for a fund in the Legg Mason fund complex.
|
Each Trustee previously served as a trustee or director of certain predecessor funds in the fund complex, and each Trustee was thus
initially selected by the board of the applicable predecessor funds. In connection with a restructuring of the fund complex completed in 2007, the Board was established to oversee mutual funds in the fund complex that invest primarily in equity
securities, including the fund, with a view to ensuring continuity of representation by board members of predecessor funds on the Board and in order to establish a Board with experience in and focused on overseeing equity mutual funds, which
experience would be further developed and enhanced over time.
In connection with the restructuring, the Trustees were
selected to join the Board based upon the following as to each Trustee: character and integrity; service as a board member of predecessor funds; willingness to serve and willingness and ability to commit the time necessary to perform the duties of a
Trustee; the fact that service as a Trustee would be consistent with the requirements of the Trusts retirement policies; as to each Trustee other than Mr. Gerken, the Trustees status as not being an interested person of
the fund, as defined in the 1940 Act; and, as to Mr. Gerken, his status as a representative of Legg Mason. Independent Trustees constitute more than 75% of the Board. Mr. Gerken serves as Chairman of the Board and is an interested person
of the fund.
The Board believes that each Trustees experience, qualifications, attributes or skills on an individual
basis and in combination with those of the other Trustees lead to the conclusion that the Board possesses the requisite attributes and skills. The Board believes that the Trustees ability to review critically, evaluate, question and discuss
information provided to them, to interact effectively with the manager, the subadviser, Western Asset, other service providers, counsel and the independent registered public accounting firm, and to exercise effective business judgment in the
performance of their duties support this conclusion. In addition, the following specific experience, qualifications, attributes and/or skills apply to each Trustee.
Each Trustee has served as a board member of the fund and other funds (or predecessor funds) in the fund complex for at least eight years. Mr. Ades has substantial experience practicing law and
advising clients with respect to various business transactions. Mr. Breech has substantial experience as the chief executive of a private corporation. Mr. Crane has substantial experience as an economist, academic and business consultant.
Mr. Hubbard has substantial experience in business development and was a senior executive of an operating company. Mr. Johnson has substantial experience as the chief executive of an operating company and in the financial services
industry, including as an actuary and pension consultant. Mr. Jerome Miller had substantial experience as an executive in the asset management group of a major broker/dealer. Mr. Ken Miller has substantial experience as a senior executive
of an operating company. Mr. Murphy has substantial experience in the asset management business and has current and prior service on the boards of other mutual funds and corporations. Mr. Schlafly has substantial experience practicing law
and also serves as the president of a private corporation and as director of a bank. Mr. Viscione has substantial experience as an academic and senior executive of a major university. Mr. Gerken has been the Chairman and Chief Executive
Officer of the Trust and other funds in the fund complex since 2002 and has substantial experience as an executive and portfolio manager
40
and in leadership roles with Legg Mason and affiliated entities. References to the experience, qualifications, attributes and skills of Trustees are pursuant to requirements of the SEC, do not
constitute holding out of the Board or any Trustee as having any special expertise, and shall not impose any greater responsibility or liability on any such person or on the Board.
The Board has five standing Committees: the Audit Committee, the Contract Committee, the Performance Committee, the Governance Committee,
and the Compensation and Nominating Committee (which is a sub-committee of the Governance Committee). Each Committee is chaired by an Independent Trustee. The Audit Committee and the Governance Committee are composed of all of the Independent
Trustees. The Contract Committee is composed of four Independent Trustees. The Performance Committee is composed of three Independent Trustees and the Chairman of the Board. The Compensation and Nominating Committee is composed of four Independent
Trustees. The Lead Independent Trustee (the Lead Trustee) serves as the Chair of the Governance Committee. Where deemed appropriate, the Board may constitute ad hoc committees.
The Lead Trustee and the chairs of the Audit and Performance Committees work with the Chairman of the Board to set the agendas for Board
and committee meetings. The Lead Trustee also serves as a key point person for interaction between management and the Independent Trustees. Through the committees the Independent Trustees consider and address important matters involving the fund,
including those presenting conflicts or potential conflicts of interest for management. The Independent Trustees also regularly meet outside the presence of management and are advised by independent legal counsel. The Board has determined that its
committees help ensure that the fund has effective and independent governance and oversight. The Board also has determined that its leadership structure is appropriate, given Legg Masons sponsorship of the fund and that investors have selected
Legg Mason to provide overall management to the fund. The Board also believes that its leadership structure facilitates the orderly and efficient flow of information between the Independent Trustees and management, including the funds
subadviser and Western Asset.
The Audit Committee oversees the scope of the funds audit, the funds accounting and
financial reporting policies and practices and its internal controls. The Audit Committee assists the Board in fulfilling its responsibility for oversight of the integrity of the funds accounting, auditing and financial reporting practices,
the qualifications and independence of the funds independent registered public accounting firm and the funds compliance with legal and regulatory requirements. The Audit Committee approves, and recommends to the Board for ratification,
the selection, appointment, retention or termination of the funds independent registered public accounting firm and approves the compensation of the independent registered public accounting firm. The Audit Committee also approves all audit and
permissible non-audit services provided to the fund by the independent registered public accounting firm and all permissible non-audit services provided by the funds independent registered public accounting firm to its manager and any
affiliated service providers if the engagement relates directly to the funds operations and financial reporting. The Audit Committee also assists the Board in fulfilling its responsibility for the review and negotiation of the funds
investment management and subadvisory arrangements.
The Contract Committee is charged with assisting the Board in requesting
and evaluating such information from the manager and the subadviser and Western Asset as may reasonably be necessary to evaluate the terms of the funds investment management agreement, subadvisory arrangements and distribution arrangements.
The Performance Committee is charged with assisting the Board in carrying out its oversight responsibilities over the fund
and fund management with respect to investment management, objectives, strategies, policies and procedures, performance and performance benchmarks, and the applicable risk management process.
The Governance Committee is charged with overseeing Board governance and related Trustee practices, including selecting and nominating
persons for election or appointment by the Board as Trustees of the Trust. The Governance Committee has formed the Compensation and Nominating Committee, the function of which is to recommend to the Board the appropriate compensation for serving as
a Trustee on the Board. In addition, the
41
Compensation and Nominating Committee is responsible for, among other things, selecting and recommending candidates to fill vacancies on the Board. The Committee may consider nominees recommended
by a shareholder. In evaluating potential nominees, including any nominees recommended by shareholders, the Committee takes into consideration various factors, including, among any others it may deem relevant, character and integrity, business and
professional experience, and whether the committee believes the person has the ability to apply sound and independent business judgment and would act in the interest of the fund and its shareholders. Shareholders who wish to recommend a nominee
should send recommendations to the Trusts Secretary that include all information relating to such person that is required to be disclosed in solicitations of proxies for the election of Trustees. A recommendation must be accompanied by a
written consent of the individual to stand for election if nominated by the Board and to serve if elected by the shareholders.
Service providers to the fund, primarily the funds manager, the subadviser and Western Asset and, as appropriate, their affiliates,
have responsibility for the day-to-day management of the fund, which includes responsibility for risk management. As an integral part of its responsibility for oversight of the fund, the Board oversees risk management of the funds investment
program and business affairs. Oversight of the risk management process is part of the Boards general oversight of the fund and its service providers. The Board has emphasized to the funds manager, the subadviser and Western Asset the
importance of maintaining vigorous risk management. The Board exercises oversight of the risk management process primarily through the Audit Committee and the Performance Committee, and through oversight by the Board itself.
The fund is subject to a number of risks, including investment risk, counterparty risk, valuation risk, reputational risk, risk of
operational failure or lack of business continuity, and legal, compliance and regulatory risk. Risk management seeks to identify and address risks,
i.e.
, events or circumstances that could have material adverse effects on the business,
operations, shareholder services, investment performance or reputation of the fund. The funds manager, the funds subadviser, Western Asset, the affiliates of the manager, the funds subadviser and Western Asset or various service
providers to the fund employ a variety of processes, procedures and controls to identify various of those possible events or circumstances, to lessen the probability of their occurrence and/or to mitigate the effects of such events or circumstances
if they do occur. Different processes, procedures and controls are employed with respect to different types of risks. Various personnel, including the funds and the managers Chief Compliance Officer and the managers chief risk
officer, as well as personnel of the subadviser and Western Asset and other service providers, such as the funds independent registered public accounting firm, make periodic reports to the Audit Committee, the Performance Committee or to the
Board with respect to various aspects of risk management, as well as events and circumstances that have arisen and responses thereto. The Board recognizes that not all risks that may affect the fund can be identified, that it may not be practical or
cost-effective to eliminate or mitigate certain risks, that it may be necessary to bear certain risks (such as investment-related risks) to achieve the funds goals, and that the processes, procedures and controls employed to address certain
risks may be limited in their effectiveness. Moreover, reports received by the Trustees as to risk management matters are typically summaries of the relevant information. As a result of the foregoing and other factors, the Boards risk
management oversight is subject to inherent limitations.
The Board met
[ ] times during the fiscal year ended [ ]. The Audit Committee, the Contract Committee, the Performance Committee, the Governance Committee, and the
Compensation and Nominating Committee met [ ], [ ],
[ ], [ ], and [ ] time(s),
respectively, during the fiscal year ended [ ].
42
The following table shows the amount of equity securities owned by the Trustees in the fund
and other investment companies in the fund complex overseen by the Trustees as of December 31, 2012.
|
|
|
|
|
|
|
|
|
Name of Trustee
|
|
Dollar Range of
Equity Securities in
the Fund ($)
|
|
|
Aggregate Dollar Range
of Equity Securities In
Registered
Investment
Companies Overseen
by Trustee ($)
|
|
Independent Trustees
|
|
|
|
|
|
|
|
|
Paul R. Ades
|
|
|
None
|
|
|
|
Over 100,000
|
|
Andrew L. Breech
|
|
|
None
|
|
|
|
Over 100,000
|
|
Dwight B. Crane
|
|
|
None
|
|
|
|
Over 100,000
|
|
Frank G. Hubbard
|
|
|
None
|
|
|
|
Over 100,000
|
|
Howard J. Johnson
|
|
|
None
|
|
|
|
Over 100,000
|
|
Jerome H. Miller
|
|
|
None
|
|
|
|
Over 100,000
|
|
Ken Miller
|
|
|
None
|
|
|
|
Over 100,000
|
|
John J. Murphy
|
|
|
None
|
|
|
|
Over 100,000
|
|
Thomas F. Schlafly
|
|
|
None
|
|
|
|
Over 100,000
|
|
Jerry A. Viscione
|
|
|
None
|
|
|
|
Over 100,000
|
|
Interested Trustee
|
|
|
|
|
|
|
|
|
R. Jay Gerken
|
|
|
None
|
|
|
|
Over 100,000
|
|
As of [ ], 2013, none of the
Independent Trustees or their immediate family members owned beneficially or of record any securities of the manager, subadviser, Western Asset or the distributor of the fund or of a person (other than a registered investment company) directly or
indirectly controlling, controlled by or under common control with the manager, subadviser, Western Asset or the distributor of the fund.
The Independent Trustees receive a fee for each meeting of the Board and committee meetings attended and are reimbursed for all out-of-pocket expenses relating to attendance at such meetings.
Mr. Gerken, an interested person of the fund, as defined in the 1940 Act, does not receive compensation from the fund for his service as Trustee, but may be reimbursed for all out-of-pocket expenses relating to attendance at such
meetings.
The fund pays a pro rata share of the Trustees fees based upon asset size. The fund currently pays each of
the Independent Trustees its pro rata share of: an annual fee of $120,000, plus $20,000 for each regularly scheduled Board meeting attended in person, and $1,000 for each telephonic Board meeting in which that Trustee participates. The Lead Trustee
receives an additional $25,000 per year, the Chair of the Audit Committee receives an additional $15,000 per year and the Chairs of the Contract Committee, the Performance Committee, and the Compensation and Nominating Committee receive an
additional $12,500 per year. Other members of the Contract Committee, the Performance Committee, and the Compensation and Nominating Committee receive an additional $10,000 per year.
Officers of the Trust receive no compensation from the fund, although they may be reimbursed by the fund for reasonable out-of-pocket
travel expenses for attending Board meetings.
Information regarding compensation paid to the Trustees is shown below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Name of Trustee
|
|
Aggregate
Compensation
from the
Fund
(2)
($)
|
|
|
Total Pension
or
Retirement
Benefits Paid as
Part of Fund
Expenses ($)
|
|
|
Total
Compensation
from Fund
Complex Paid
to Trustee
(3)
($)
|
|
|
Number of
Portfolios in
Fund Complex
Overseen by
Trustee
|
|
Independent Trustees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Paul R. Ades
|
|
|
[
|
]
|
|
|
None
|
|
|
|
[
|
]
|
|
|
49
|
|
Andrew L. Breech
|
|
|
[
|
]
|
|
|
None
|
|
|
|
[
|
]
|
|
|
49
|
|
Dwight B. Crane
|
|
|
[
|
]
|
|
|
None
|
|
|
|
[
|
]
|
|
|
49
|
|
Frank G. Hubbard
|
|
|
[
|
]
|
|
|
None
|
|
|
|
[
|
]
|
|
|
49
|
|
Howard J. Johnson
|
|
|
[
|
]
|
|
|
None
|
|
|
|
[
|
]
|
|
|
49
|
|
43
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Name of Trustee
|
|
Aggregate
Compensation
from the
Fund
(2)
($)
|
|
|
Total Pension
or
Retirement
Benefits Paid as
Part of Fund
Expenses ($)
|
|
|
Total
Compensation
from Fund
Complex Paid
to Trustee
(3)
($)
|
|
|
Number of
Portfolios in
Fund Complex
Overseen by
Trustee
|
|
Jerome H. Miller
|
|
|
[
|
]
|
|
|
None
|
|
|
|
[
|
]
|
|
|
49
|
|
Ken Miller
|
|
|
[
|
]
|
|
|
None
|
|
|
|
[
|
]
|
|
|
49
|
|
John J. Murphy
|
|
|
[
|
]
|
|
|
None
|
|
|
|
[
|
]
|
|
|
49
|
|
Thomas F. Schlafly
|
|
|
[
|
]
|
|
|
None
|
|
|
|
[
|
]
|
|
|
49
|
|
Jerry A. Viscione
|
|
|
[
|
]
|
|
|
None
|
|
|
|
[
|
]
|
|
|
49
|
|
Interested Trustee
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
R. Jay Gerken
(1)
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
159
|
|
(1)
|
Mr. Gerken was not compensated for his services as a Trustee because of his affiliation with the manager.
|
(2)
|
As the fund had
not commenced operations on [ ], 2013, information is estimated for the calendar year ending December 31, 2012.
|
(3)
|
Information is for
the calendar year ended December 31, 2012.
|
As of
[ ], 2013, the Trustees and officers of the Trust, as a group, owned less than 1% of the outstanding shares of the fund.
As of [ ], 2013, no shareholders or groups (as the
term is used in Section 13(d) of the Securities Exchange Act of 1934 (the 1934 Act)) owned beneficially or of record 5% or more of the outstanding shares of any class of the fund. Legg Mason, Inc. owned all of the outstanding shares
of the fund prior to its public offering.
INVESTMENT MANAGEMENT AND OTHER SERVICES
Manager
LMPFA serves as investment manager to the fund, pursuant to an investment management agreement (the Management Agreement).
LMPFA provides administrative and certain oversight services to the fund. LMPFA, with offices at 620 Eighth Avenue, New York, New York 10018, also serves as the investment manager of other Legg Mason-sponsored funds. As of
[ ], 20[ ], LMPFAs total assets under management were approximately $[ ]
billion. LMPFA is a wholly-owned subsidiary of Legg Mason. Legg Mason, whose principal executive offices are at 100 International Drive, Baltimore, Maryland 21202, is a global asset management company. As of
[ ], 20[ ], Legg Masons asset management operations had aggregate assets under management of approximately
$[ ] billion.
The manager has agreed, under the
Management Agreement, subject to the supervision of the funds Board, to provide the fund with investment research, advice, management and supervision; furnish a continuous investment program for the funds portfolio of securities and
other investments consistent with the funds investment objective, policies and restrictions; and place orders pursuant to its investment determinations. The manager is permitted to enter into contracts with subadvisers or subadministrators,
subject to the Boards approval. The manager has entered into subadvisory arrangements, as described below.
The manager
performs administrative and management services as reasonably requested by the fund necessary for the operation of the fund, such as (i) supervising the overall administration of the fund, including negotiation of contracts and fees with and
the monitoring of performance and billings of the funds transfer agent, shareholder servicing agents, custodian and other independent contractors or agents; (ii) providing certain compliance, fund accounting, regulatory reporting and tax
reporting services; (iii) preparing or participating in the preparation of Board materials, registration statements, proxy statements and reports and other communications to shareholders; (iv) maintaining the funds existence; and
(v) maintaining the registration and qualification of the funds shares under federal and state laws.
44
The Management Agreement will continue in effect for its initial term and thereafter from
year to year, provided such continuance is specifically approved at least annually (a) by the Board or by a majority of the outstanding voting securities of the fund (as defined in the 1940 Act), and (b) in either event, by a majority of
the Independent Trustees with such Independent Trustees casting votes in person at a meeting called for such purpose.
The
Management Agreement provides that the manager may render services to others. The Management Agreement is terminable without penalty on not more than 60 days nor less than 30 days written notice by the fund when authorized either by a
vote of holders of shares representing a majority of the voting power of the outstanding voting securities of the fund (as defined in the 1940 Act) or by a vote of a majority of the Trustees, or by the manager on not less than 90 days written
notice, and will automatically terminate in the event of its assignment (as defined in the 1940 Act). The Management Agreement is not assignable by the Trust except with the consent of the manager. The Management Agreement provides that neither the
manager nor its personnel shall be liable for any error of judgment or mistake of law or for any loss arising out of any investment or for any act or omission in the execution of security transactions for the fund, except for willful misfeasance,
bad faith or gross negligence or reckless disregard of its or their obligations and duties.
For its services under the
Management Agreement, LMPFA receives an investment management fee that is calculated daily and payable monthly at the annual rate of [ ]% of the funds average daily net
assets.
As the fund will commence operations on [ ],
2013, the fund paid no management fees to LMPFA as of the date of this SAI.
Subadvisory Arrangements
Batterymarch Financial Management (Batterymarch or the subadviser) serves as the subadviser to the fund pursuant
to a subadvisory agreement between the manager and Batterymarch (the Subadvisory Agreement). Batterymarch was established in 1969 and has offices at John Hancock Tower, 200 Clarendon Street, Boston, Massachusetts 02116. Batterymarch
provides asset management services primarily for institutional accounts, such as pension and profit sharing plans, endowments and foundations, investment companies (including mutual funds) and state and municipal and foreign governmental entities.
As of [ ], 20[ ], Batterymarchs total assets under management were approximately
$[ ] billion.
Western Asset manages the funds
cash and short-term instruments pursuant to an agreement between the manager and Western Asset (the Western Asset Agreement). Western Asset, established in 1971, has offices at 385 East Colorado Boulevard, Pasadena, California 91101 and
620 Eighth Avenue, New York, New York 10018. Western Asset acts as investment adviser to institutional accounts, such as corporate pension plans, mutual funds and endowment funds. As of
[ ], 20[ ], the total assets under management of Western Asset and its supervised affiliates were approximately
$[ ] billion.
Batterymarch and Western Asset are
wholly-owned subsidiaries of Legg Mason. Legg Mason, whose principal executive offices are at 100 International Drive, Baltimore, Maryland 21202, is a global asset management company. As of
[ ], 20[ ], Legg Masons asset management operations had aggregate assets under management of approximately
$[ ] billion.
Under the Subadvisory Agreement and the
Western Asset Agreement, subject to the supervision and direction of the Board and the manager, the subadviser and Western Asset will manage the funds portfolio in accordance with the funds stated investment objective and policies,
assist in supervising all aspects of the funds operations, make investment decisions for the fund, place orders to purchase and sell securities and employ professional portfolio managers and securities analysts who provide research services to
the fund.
45
Each of the Subadvisory Agreement and the Western Asset Agreement will continue in effect
for its initial term and thereafter from year to year provided such continuance is specifically approved at least annually (a) by the Board or by a majority of the outstanding voting securities of the fund (as defined in the 1940 Act), and
(b) in either event, by a majority of the Independent Trustees with such Independent Trustees casting votes in person at a meeting called for such purpose. The Board or a majority of the outstanding voting securities of the fund (as defined in
the 1940 Act) may terminate the Subadvisory Agreement or the Western Asset Agreement without penalty, in each case on not more than 60 days nor less than 30 days written notice to the subadviser or Western Asset. Each of the subadviser
and Western Asset may terminate the Subadvisory Agreement or the Western Asset Agreement, as applicable, on 90 days written notice to the fund and the manager. Each of the Subadvisory Agreement and the Western Asset Agreement may be terminated
upon the mutual written consent of the manager and the subadviser or Western Asset, as applicable. Each of the Subadvisory Agreement and the Western Asset Agreement will terminate automatically in the event of assignment (as defined in the 1940 Act)
by the subadviser or Western Asset, as applicable, and shall not be assignable by the manager without the consent of the subadviser or Western Asset, as applicable.
As compensation for their subadvisory services, the manager pays the subadviser and Western Asset an aggregate fee equal to [ ]% of
the management fee paid to LMPFA, net of fee waivers and expense reimbursements.
Portfolio Managers
The following tables set forth certain additional information with respect to the portfolio managers for the fund. Unless noted otherwise,
all information is provided as of [ ], 20[ ].
Other Accounts Managed by the Portfolio Managers
The table below identifies the portfolio managers, the number of accounts (other than the fund) for which the portfolio managers have day-to-day management responsibilities and the total assets in such
accounts, within each of the following categories: registered investment companies, other pooled investment vehicles, other accounts and, if applicable, the number of accounts and total assets in the accounts where fees are based on performance.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Type of Account
|
|
Number of
Accounts
Managed
|
|
|
Total Assets
Managed ($)
|
|
|
Number of
Accounts Managed
for which Advisory
Fee
is
Performance-Based
|
|
|
Assets
Managed for
which Advisory
Fee
is
Performance-
Based ($)
|
|
Stephen A. Lanzendorf, CFA*
|
|
Registered investment companies
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
Other pooled investment vehicles
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
Other accounts
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
|
|
|
|
Joseph S. Giroux*
|
|
Registered investment companies
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
Other pooled investment vehicles
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
Other accounts
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
|
|
|
|
Jeremy Wee, CFA*
|
|
Registered investment companies
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
Other pooled investment vehicles
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
Other accounts
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
|
|
[
|
]
|
46
*Batterymarchs Developed Markets team provides management support for this fund.
Members of the investment team may change from time to time. Mr. Lanzendorf , Giroux and Wee are responsible for the strategic oversight of the funds investments. Their focus is on portfolio structure, and they are primarily responsible
for ensuring that the fund complies with its investment objective, guidelines and restrictions, and Batterymarchs current internal investment strategies.
Investment Professional Compensation
Portfolio Manager Compensation Structure
In addition to customary employee benefits (
e.g.,
medical coverage), compensation for investment professionals
includes:
|
|
|
competitive base salaries;
|
|
|
|
individual performance-based bonuses based on the investment professionals added value to the products for which they are responsible measured on
a one-, three- and five-year basis versus benchmarks and peer universes as well as their contributions to research, client service and new business development;
|
|
|
|
corporate profit sharing; and an annual contribution to a non-qualified deferred compensation plan that has a cliff-vesting requirement (
i.e.,
they must remain employed with the firm for 31 months to receive payment).
|
Performance is evaluated on an
aggregate product basis that a portfolio manager is responsible for and is generally not analyzed by any individual client portfolios. Portfolio manager compensation is not tied to, nor increased or decreased as the direct result of, any performance
fees that may be earned by Batterymarch. Lastly, portfolio managers do not receive a percentage of the revenue earned on any of Batterymarchs client portfolios.
Potential Conflicts of Interest
As an investment adviser to
multiple client accounts, Batterymarch recognizes that actual or potential conflicts of interest may arise in its business and accordingly has developed compliance policies and procedures that it believes are reasonably designed to detect, prevent
and/or minimize the effects of such conflicts of interest. Nevertheless, clients should be aware that no set of policies and procedures can possibly anticipate or relieve all potential conflicts of interest. The following is a summary of certain
potential conflicts of interest that may arise in managing multiple client accounts:
Allocation of Limited Investment
Opportunities
. If a portfolio manager identifies a limited investment opportunity (including initial public offerings) that may be suitable for multiple funds and/or accounts, the investment opportunity may be allocated among these several funds
or accounts, which may limit a clients ability to take full advantage of the investment opportunity, due to liquidity constraints or other factors.
Batterymarch has adopted trade allocation procedures designed to ensure that allocations of limited investment opportunities are conducted in a fair and equitable manner between client accounts.
Nevertheless, investment opportunities may be allocated differently among client accounts due to the particular characteristics of an account, such as the size of the account, cash position, investment guidelines and restrictions or its
sector/country/region exposure or other risk controls, market restrictions or for other reasons.
Different Investment
Strategies
. Batterymarch provides investment advisory services for multiple funds and accounts and under multiple investment strategies and may give advice, and take action, with respect to any of those funds or accounts, that may differ from
the advice given, or the timing or nature of action taken, with respect to any other individual fund or account. At times, one or more portfolio managers may determine that an investment opportunity may be appropriate for only some of the funds
and/or accounts for which he or she exercises investment responsibility, or may decide that certain of the funds and/or accounts should take differing positions with respect to a particular security.
47
For example, certain portfolio managers that manage long-only portfolios also manage
portfolios that sell securities short. The stock selection models, risk controls and portfolio construction rules used by Batterymarch to manage its clients long-only portfolios may differ from the models and rules that are used to manage
client account portfolios that hold securities short, which may result in similar securities being ranked differently for the different investment strategies. As a result, Batterymarch may purchase or sell a security in one or more of its long-only
portfolios under management during the same day it executes an opposite transaction in the same or a similar security for one or more of its portfolios under management that hold securities short, and certain account portfolios may contain
securities sold short that are simultaneously held as long positions in certain long-only portfolios managed by Batterymarch.
Timing of Trades
. To lessen the market impact of securities transactions, Batterymarch often limits daily trading volumes and
aggregates trades for multiple funds and accounts, where feasible. However, at times, some accounts may separately trade a particular security in advance of other accounts. In such situations, a purchase may increase the value of a security
previously purchased by another account, or a sale or short sale in one account may lower the sale price received in a sale by a second account.
Broker Selection and Soft Dollar Usage
. Portfolio managers may be able to influence the selection of the broker-dealers that are used to execute securities transactions for the funds and/or
accounts they manage. In addition to executing trades, some brokers and dealers provide brokerage and research services, which may result in the payment of higher brokerage commissions than might otherwise be available and may provide an incentive
to increase trading with such brokers. All soft dollar arrangements in which Batterymarch is involved shall come within the safe harbor of Section 28(e) of the Securities Exchange Act of 1934, as amended, and the rules and interpretations
thereof as issued by the Securities and Exchange Commission. Nonetheless, the research services obtained from brokers and dealers may be may be used to service other clients than those paying commissions to the broker-dealers providing the research
services, and also may benefit some funds or accounts more than others.
Differences in Financial Incentives
. A
conflict of interest may arise where the financial or other benefits available to a portfolio manager or an investment adviser differ among the funds and/or accounts under management. For example, when the structure of an investment advisers
management fee differs among the funds and/or accounts under its management (such as where certain funds or accounts pay higher management fees or performance-based management fees), a portfolio manager might be motivated to favor certain funds
and/or accounts over others. Performance-based fees could also create an incentive for an investment adviser to make investments that are riskier or more speculative. In addition, a portfolio manager might be motivated to favor funds and/or accounts
in which he or she or the investment adviser and/or its affiliates have a financial interest. Similarly, the desire to maintain or raise assets under management or to enhance the portfolio managers performance record in a particular investment
strategy or to derive other rewards, financial or otherwise, could influence a portfolio manager to lend preferential treatment to those funds and/or accounts that could most significantly benefit the portfolio manager.
Batterymarch allows its employees to trade in securities that it recommends to advisory clients. Batterymarchs employees may buy,
hold or sell securities at or about the same time that Batterymarch is purchasing, holding or selling the same or similar securities for client account portfolios and the actions taken by such individuals on a personal basis may differ from, or be
inconsistent with, the nature and timing of advice or actions taken by Batterymarch for its client accounts. Batterymarch and its employees may also invest in mutual funds and other pooled investment vehicles that are managed by Batterymarch. This
may result in a potential conflict of interest since Batterymarch employees have knowledge of such funds investment holdings, which is non-public information.
Batterymarch seeks to avoid these potential conflicts of interest by acting in good faith and in the best interests of clients and by not favoring or making riskier investments for accounts paying
performance-based or higher fees. Batterymarch generally requires portfolio decisions to be made on a product specific basis and
48
requires average pricing of all aggregated orders. Additionally, the investment performance of composites, not individual client accounts, is generally considered a factor in determining
portfolio managers compensation. Furthermore, Batterymarch has adopted a written Code of Ethics designed to prevent, limit and/or detect personal trading activities that may interfere or conflict with client interests.
* * * * *
Although Batterymarch believes that its policies and procedures are appropriate to prevent, eliminate or minimize the harm of many
potential conflicts of interest between Batterymarch, its related persons and clients, clients should be aware that no set of policies and procedures can possibly anticipate or relieve all potential conflicts of interest. Moreover, it is possible
that additional potential conflicts of interest may exist that Batterymarch has not identified in the summary above.
Batterymarchs Chief Compliance Officer conducts a review of the firms potential conflicts of interest and a risk assessment
on an annual basis.
Portfolio Managers Securities Ownership
The table below identifies ownership of the funds securities by the portfolio managers as of [ ], 2013.
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Portfolio Manager
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Dollar Range of
Ownership of
Securities ($)
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Stephen A. Lanzendorf, CFA
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None
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Joseph S. Giroux
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None
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Jeremy Wee, CFA
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None
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Expenses
In addition to amounts payable under the Management Agreement and the 12b-1 Plan (as discussed below), the fund is responsible for its own expenses, including, among other things: interest; taxes;
governmental fees; voluntary assessments and other expenses incurred in connection with membership in investment company organizations; organization costs of the fund; the cost (including brokerage commissions, transaction fees or charges, if any)
in connection with the purchase or sale of the funds securities and other investments and any losses in connection therewith; fees and expenses of custodians, transfer agents, registrars, independent pricing vendors or other agents; legal
expenses; loan commitment fees; expenses relating to the issuance and redemption or repurchase of the funds shares and servicing shareholder accounts; expenses of registering and qualifying the funds shares for sale under applicable
federal and state law; expenses of preparing, setting in print, printing and distributing prospectuses and statements of additional information and any supplements thereto, reports, proxy statements, notices and dividends to the funds
shareholders; costs of stationery; website costs; costs of meetings of the Board or any committee thereof, meetings of shareholders and other meetings of the fund; Board fees; audit fees; travel expenses of officers, Trustees and employees of the
fund, if any; the funds pro rata portion of premiums on any fidelity bond and other insurance covering the fund and its officers, Trustees and employees; and litigation expenses and any non-recurring or extraordinary expenses as may arise,
including, without limitation, those relating to actions, suits or proceedings to which the fund is a party and any legal obligation which the fund may have to indemnify the funds Trustees and officers with respect thereto.
Management may agree to implement an expense cap, waive fees and/or reimburse operating expenses for one or more classes of shares. Any
such waived fees and/or reimbursed expenses are described in the funds Prospectus. The expense caps and waived fees and/or reimbursed expenses do not cover extraordinary expenses, such as (a) any expenses or charges related to litigation,
derivative actions, demand related to litigation, regulatory or other government investigations and proceedings, for cause regulatory inspections and
49
indemnification or advancement of related expenses or costs, to the extent any such expenses are considered extraordinary expenses for the purposes of fee disclosure in Form N-1A as the same may
be amended from time to time; (b) transaction costs (such as brokerage commissions and dealer and underwriter spreads) and taxes; and (c) other extraordinary expenses as determined for the purposes of fee disclosure in Form N-1A, as the
same may be amended from time to time. Without limiting the foregoing, extraordinary expenses are generally those that are unusual or expected to recur only infrequently, and may include such expenses, by way of illustration, as (i) expenses of
the reorganization, restructuring, redomiciling or merger of the fund or class or the acquisition of all or substantially all of the assets of another fund or class; (ii) expenses of holding, and soliciting proxies for, a meeting of
shareholders of the fund or class (except to the extent relating to routine items such as the election of Trustees or the approval of the independent registered public accounting firm); and (iii) expenses of converting to a new custodian,
transfer agent or other service provider, in each case to the extent any such expenses are considered extraordinary expenses for the purposes of fee disclosure in Form N-1A as the same may be amended from time to time.
In order to implement an expense cap, the manager will, as necessary, waive management fees or reimburse operating expenses. However, the
manager is permitted to recapture amounts previously waived or reimbursed by the manager to the fund during the same fiscal year if the funds total annual operating expenses have fallen to a level below the expense cap shown in the funds
Prospectus. In no case will the manager recapture any amount that would result, on any particular fund business day, in the funds total annual operating expenses exceeding the expense cap.
Distributor
LMIS, a
wholly-owned broker/dealer subsidiary of Legg Mason, located at 100 International Drive, Baltimore, Maryland 21202, serves as the funds sole and exclusive distributor pursuant to a written agreement dated August 5, 2010 (the
distribution agreement).
LMIS may be deemed to be an underwriter for purposes of the 1933 Act. The
distributors obligation is an agency or best efforts arrangement under which the distributor is required to take and pay only for such shares of the fund as may be sold to the public. The distributor is not obligated to sell any
stated number of shares.
The distribution agreement is renewable from year to year if approved (a) by the Trustees or by
a vote of a majority of the funds outstanding voting securities, and (b) by the affirmative vote of a majority of Independent Trustees who are not parties to such agreement or interested persons of any such party by votes cast in person
at a meeting called for such purpose. The distribution agreement provides that it will terminate if assigned, and that it may be terminated without penalty by either party on 60 days written notice.
Shareholder Services and Distribution Plan
The Trust, on behalf of the fund, has adopted an amended shareholder services and distribution plan (the 12b-1 Plan) pursuant to Rule 12b-1 under the 1940 Act with respect to its
Class A, Class C, Class FI and Class R shares. Under the 12b-1 Plan, the fund pays distribution fees to LMIS for the services it provides and expenses it bears with respect to the distribution of Class C and Class R
shares and service fees for Class A, Class C, Class FI and Class R shares. The distributor will provide the Board with periodic reports of amounts expended under the 12b-1 Plan and the purposes for which such expenditures were
made. The fund pays service fees, accrued daily and payable monthly, calculated at the annual rate of 0.25% of the value of the funds average daily net assets attributable to the funds Class A, Class C, Class FI and
Class R shares. In addition, the fund pays distribution fees with respect to the Class C shares at the annual rate of 0.75% of the funds average daily net assets attributable to each such class and with respect to the
Class R shares at the annual rate of 0.25% of the funds average daily net assets attributable to such class.
Fees
under the 12b-1 Plan may be used to make payments to the distributor for distribution services, Service Agents and other parties in respect of the sale of shares of the fund, and to make payments for advertising,
50
marketing or other promotional activity, and payments for preparation, printing and distribution of prospectuses, statements of additional information and reports for recipients other than
regulators and existing shareholders. The fund may also make payments to the distributor, Service Agents and others for providing personal service or the maintenance of shareholder accounts. The amounts paid to each recipient may vary based upon
certain factors, including, among other things, the levels of sales of fund shares and/or shareholder services provided.
The
12b-1 Plan also provides that the distributor and Service Agents may receive all or a portion of the sales charges paid by Class A and Class C investors.
The 12b-1 Plan permits the fund to pay fees to the distributor, Service Agents and others as compensation for their services, not as reimbursement for specific expenses incurred. Thus, even if their
expenses exceed the fees provided for by the 12b-1 Plan, the fund will not be obligated to pay more than those fees and, if their expenses are less than the fees paid to them, they will realize a profit. The fund may pay the fees to the distributor
and others until the 12b-1 Plan or distribution agreement is terminated or not renewed. In that event, the distributors or other recipients expenses in excess of fees received or accrued through the termination date will be the
distributors or other recipients sole responsibility and not obligations of the fund. In their annual consideration of the continuation of the 12b-1 Plan for the fund, the Trustees will review the 12b-1 Plan and the expenses for each
class within the fund separately.
The 12b-1 Plan also recognizes that various service providers to the fund, such as the
manager, may make payments for distribution-related expenses out of their own resources, including past profits, or payments received from the fund for other purposes, such as management fees, and that the funds distributor or Service Agents
may from time to time use their own resources for distribution-related services, in addition to the fees paid under the 12b-1 Plan. The 12b-1 Plan specifically provides that, to the extent that such payments might be deemed to be indirect financing
of any activity primarily intended to result in the sale of shares of the fund within the context of Rule 12b-1, then the payments are deemed to be authorized by the 12b-1 Plan, if permitted under applicable law.
The 12b-1 Plan continues in effect if such continuance is specifically approved at least annually by a vote of both a majority of the
Trustees and a majority of the Independent Trustees of the Trust who have no direct or indirect financial interest in the operation of the 12b-1 Plan or in any agreement related to the 12b-1 Plan (for purposes of this paragraph Qualified
Trustees). The Qualified Trustees, in the exercise of their business judgment in the best interests of the shareholders of the fund and each class, have approved the continuation of the 12b-1 Plan. The 12b-1 Plan requires that the fund and the
distributor provide to the Board and the Board review, at least quarterly, a written report of the amounts expended (and the purposes therefor) under the 12b-1 Plan. The 12b-1 Plan further provides that the selection and nomination of the
Qualified Trustees is committed to the discretion of the Qualified Trustees then in office. The 12b-1 Plan may be terminated with respect to any class of the fund at any time by a vote of a majority of the funds Qualified Trustees or by a vote
of a majority of the outstanding voting securities of that class. The 12b-1 Plan may not be amended to increase materially the amount of permitted expenses of the class thereunder without the approval of a majority of the outstanding securities of
that class and may not be materially amended in any case without a vote of a majority of both the Trustees and Qualified Trustees. The fund will preserve copies of any plan, agreement or report made pursuant to the 12b-1 Plan for a period of not
less than six years, and for the first two years the fund will preserve such copies in an easily accessible place.
As
contemplated by the 12b-1 Plan, the distributor acts as an agent of the fund in connection with the offering of shares of the fund pursuant to the distribution agreement.
Dealer reallowances, if any, are described in the funds Prospectus.
As the
fund will commence operations on [ ], 2013, the fund paid no service or distribution fees pursuant to the 12b-1 plan as of the date of this SAI.
51
Custodian and Transfer Agent
State Street Bank and Trust Company (State Street), One Lincoln Street, Boston, Massachusetts 02111, serves as the custodian of the fund. State Street, among other things, maintains a custody
account or accounts in the name of the fund, receives and delivers all assets for the fund upon purchase and upon sale or maturity, collects and receives all income and other payments and distributions on account of the assets of the fund and makes
disbursements on behalf of the fund. State Street neither determines the funds investment policies nor decides which securities the fund will buy or sell. For its services, State Street receives a monthly fee based upon the daily average
market value of securities held in custody and also receives securities transaction charges, including out-of-pocket expenses. The fund may also periodically enter into arrangements with other qualified custodians with respect to certain types of
securities or other transactions such as repurchase agreements or derivatives transactions. State Street may also act as the funds securities lending agent and in that case would receive a share of the income generated by such activities.
Boston Financial Data Services, Inc. (the transfer agent), located at 2000 Crown Colony Drive, Quincy,
Massachusetts 02169, serves as the funds transfer agent. Under the transfer agency agreement, the transfer agent maintains the shareholder account records for the fund, handles certain communications between shareholders and the fund and
distributes dividends and distributions payable by the fund. For these services, the transfer agent receives a monthly fee computed on the basis of the number of shareholder accounts it maintains for the fund during the month and is reimbursed for
out-of-pocket expenses.
Counsel
Willkie Farr & Gallagher LLP, 787 Seventh Avenue, New York, New York 10019, serves as counsel to the Trust and the fund.
Stroock & Stroock & Lavan LLP, 180 Maiden Lane, New York, New York 10038, serves as counsel to the Independent Trustees.
Independent Registered Public Accounting Firm
[ ], an independent registered public accounting firm, located at
[ ], has been selected to audit and report upon the funds financial statements and financial highlights for the fiscal year ending
[ ], 2013.
Code of Ethics
Pursuant to Rule 17j-1 under the 1940 Act, the fund, the manager, the subadviser, Western Asset and the distributor have adopted codes of
ethics that permit personnel to invest in securities for their own accounts, including securities that may be purchased or held by the fund. All personnel must place the interests of clients first and avoid activities, interests and relationships
that might interfere with the duty to make decisions in the best interests of the clients. All personal securities transactions by employees must adhere to the requirements of the codes and must be conducted in such a manner as to avoid any actual
or potential conflict of interest, the appearance of such a conflict or the abuse of an employees position of trust and responsibility. Copies of the codes of ethics of the fund, the manager, the subadviser, Western Asset and the distributor
are on file with the SEC.
Proxy Voting Guidelines and Procedures
Although individual Trustees may not agree with particular policies or votes by the manager, the Board has delegated proxy voting
discretion to the manager, believing that the manager should be responsible for voting because it is a matter relating to the investment decision making process.
52
LMPFA delegates the responsibility for voting proxies for the fund to the subadviser through
its contract with the subadviser. The subadviser will use its own proxy voting policies and procedures to vote proxies. Accordingly, LMPFA does not expect to have proxy-voting responsibility for the fund. Should LMPFA become responsible for voting
proxies for any reason, such as the inability of the subdaviser to provide investment advisory services, LMPFA shall utilize the proxy voting guidelines established by the most recent subadviser to vote proxies until a new subadviser is retained. In
the case of a material conflict between the interests of LMPFA (or its affiliates if such conflict is known to persons responsible for voting at LMPFA) and the fund, the Board of Directors of LMPFA shall consider how to address the conflict and/or
how to vote the proxies. LMPFA shall maintain records of all proxy votes in accordance with applicable securities laws and regulations, to the extent that LMPFA votes proxies. LMPFA shall be responsible for gathering relevant documents and records
related to proxy voting from the subadviser and providing them to the fund as required for the fund to comply with applicable rules under the 1940 Act.
The subadvisers proxy voting policies and procedures govern in determining how proxies relating to the funds portfolio securities are voted, a copy of which is attached as Appendix B to this
SAI. Information regarding how the fund voted proxies (if any) relating to portfolio securities during the most recent 12-month period ended June 30 is available without charge (1) by calling 1-877-721-1926, (2) on the funds
website at http://www.leggmason.com/individualinvestors and (3)
on the SECs website at http://www.sec.gov.
PURCHASE OF SHARES
General
Investors may
purchase shares from a Service Agent. In addition, certain investors, including retirement plans purchasing through certain Service Agents, may purchase shares directly from the fund. When purchasing shares of the fund, investors must specify
whether the purchase is for Class A, Class C, Class FI, Class R, Class I or Class IS shares. Service Agents may charge their customers an annual account maintenance fee in connection with a brokerage account through which an investor purchases
or holds shares. Accounts held directly at the transfer agent are not subject to a maintenance fee.
For additional
information regarding applicable investment minimums and eligibility requirements, please see the funds Prospectus.
There are minimum investment requirements of $1,000 for initial investments and $50 for subsequent investments for purchases of
Class A shares by: (i) current and retired board members of Legg Mason, (ii) current and retired board members of any fund advised by LMPFA or its affiliates (such board members, together with board members of Legg Mason, are referred
to herein as Board Members), (iii) current employees of Legg Mason and its affiliates, (iv) the immediate families of such persons (immediate families are such persons spouse, including the
surviving spouse of a deceased Board Member, and children under the age of 21) and (v) a pension, profit-sharing or other benefit plan for the benefit of such persons. The fund reserves the right to waive or change minimums, to decline any
order to purchase its shares and to suspend the offering of shares from time to time.
Purchase orders received by the fund
prior to the close of regular trading on the NYSE, on any day the fund calculates its NAV, are priced according to the NAV determined on that day (the trade date). Orders received by a Service Agent prior to the close of regular trading
on the NYSE on any day the fund calculates its NAV are priced according to the NAV determined on that day, provided the order is transmitted by the Service Agent to the funds transfer agent in accordance with their agreed-upon procedures.
Payment must be made with the purchase order.
Class I Shares.
The following persons are eligible to purchase Class I
shares: (i) current employees of the funds manager and its affiliates; (ii) current and former board members of investment companies managed by
53
affiliates of Legg Mason; (iii) current and former board members of Legg Mason; and (iv) the immediate families of such persons. Immediate families are such persons spouse,
including the surviving spouse of a deceased board member, and children under the age of 21. For such investors, the minimum initial investment is $1,000 and the minimum for each purchase of additional shares is $50. Current employees may purchase
additional Class I shares through a systematic investment plan.
Under certain circumstances, an investor who purchases fund
shares pursuant to a fee-based advisory account program of an Eligible Financial Intermediary as authorized by LMIS may be afforded an opportunity to make a conversion between one or more share classes owned by the investor in the same fund to Class
I shares of that fund. Such a conversion in these particular circumstances does not cause the investor to realize taxable gain or loss.
Systematic Investment Plan.
Shareholders may make additions to their accounts at any time by purchasing shares through a service known as the Systematic Investment Plan. Under the Systematic
Investment Plan, the distributor or the transfer agent is authorized through preauthorized transfers of at least $50 on a monthly, quarterly, every alternate month, semi-annual or annual basis to charge the shareholders account held with a
bank or other financial institution as indicated by the shareholder, to provide for systematic additions to the shareholders fund account. A shareholder who has insufficient funds to complete the transfer will be charged a fee of up to $25 by
the distributor or the transfer agent. The Systematic Investment Plan authorizes the distributor to apply cash held in the shareholders brokerage account to make additions to the account. Additional information is available from the fund or a
Service Agent.
Sales Charge Alternatives
The following classes of shares are available for purchase. See the Prospectus for a discussion of who is eligible to purchase certain classes and of factors to consider in selecting which class of shares
to purchase.
Class A Shares.
Class A shares are sold to investors at the public offering price, which is the
NAV plus an initial sales charge, as described in the funds Prospectus.
Members of the selling group may receive a
portion of the sales charge as described in the funds Prospectus and may be deemed to be underwriters of the fund as defined in the 1933 Act. Sales charges are calculated based on the aggregate of purchases of Class A shares of the fund
made at one time by any person, which includes an individual and his or her spouse and children under the age of 21, or a trustee or other fiduciary of a single trust estate or single fiduciary account. For additional information
regarding sales charge reductions, see Sales Charge Waivers and Reductions below.
You do not pay an initial sales
charge when you buy $1,000,000 or more of Class A shares. However, if you redeem these Class A shares within 18 months of purchase (or within 12 months for shares purchased prior to August 1, 2012), you will pay a contingent deferred
sales charge of 1.00%.
The contingent deferred sales charge is waived in the same circumstances in which the contingent
deferred sales charge applicable to Class C shares is waived. See Contingent Deferred Sales Charge Provisions and Waivers of Contingent Deferred Sales Charge below.
Class C Shares.
Class C shares are sold without an initial sales charge but are subject to a contingent deferred sales charge
payable upon certain redemptions. See Contingent Deferred Sales Charge Provisions below.
Class FI, Class R,
Class I and Class IS Shares.
Class FI, Class R, Class I and Class IS shares are sold at NAV with no initial sales charge and no contingent deferred sales charge upon redemption.
54
Sales Charge Waivers and Reductions
Initial Sales Charge Waivers.
Purchases of Class A shares may be made at NAV without an initial sales charge in the following
circumstances:
(a) sales to (i) current and retired Board Members, (ii) current employees of Legg
Mason and its subsidiaries, (iii) the immediate families of such persons (immediate families are such persons spouse, including the surviving spouse of a deceased Board Member, and children under the age of
21) and (iv) a pension, profit-sharing or other benefit plan for the benefit of such persons;
(b)
sales to any employees of Service Agents having dealer, service or other selling agreements with the funds distributor or otherwise having an arrangement with any such Service Agent with respect to sales of fund shares, and by the immediate
families of such persons or by a pension, profit-sharing or other benefit plan for the benefit of such persons (providing the purchase is made for investment purposes and such securities will not be resold except through redemption or repurchase);
(c) offers of Class A shares to any other investment company to effect the combination of such company
with the fund by merger, acquisition of assets or otherwise;
(d) purchases by shareholders who have redeemed
Class A shares in the fund (or Class A shares of another fund sold by the distributor that is offered with a sales charge) and who wish to reinvest their redemption proceeds in the fund, provided the reinvestment is made within 60 calendar
days of the redemption;
(e) purchases by certain separate accounts used to fund unregistered variable annuity
contracts;
(f) purchases by investors participating in wrap fee or asset allocation programs or
other fee-based arrangements sponsored by broker/dealers and other financial institutions that have entered into agreements with LMIS; and
(g) purchases by direct retail investment platforms through mutual fund supermarkets, where the sponsor links its clients account (including IRA accounts on such platforms) to a master
account in the sponsors name.
In order to obtain such discounts, the purchaser must provide sufficient information at
the time of purchase to permit verification that the purchase qualifies for the elimination of the sales charge.
There are
several ways you can combine multiple purchases of Class A shares of funds sold by the distributor to take advantage of the breakpoints in the sales charge schedule. In order to take advantage of reductions in sales charges that may be
available to you when you purchase fund shares, you must inform your Service Agent or the fund if you are eligible for a letter of intent or a right of accumulation and if you own shares of other funds that are eligible to be aggregated with your
purchases. Certain records, such as account statements, may be necessary in order to verify your eligibility for a reduced sales charge.
Accumulation Privilege
allows you to combine the current value of Class A shares of the fund with other shares of funds sold by the distributor that are owned by:
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your spouse, and children under the age of 21
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with the dollar amount of your next purchase of Class A shares for purposes of calculating the initial sales charges.
If you hold fund shares in accounts at two or more Service Agents, please contact your Service Agents to determine which
shares may be combined.
55
For purposes of the accumulation privilege:
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You can combine shares of funds sold by the distributor that are offered with a sales charge, which includes shares of money market funds sold by the
distributor that were acquired by exchange from other funds offered with a sales charge.
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You may generally not combine shares of other funds that are not offered with a sales charge. For example, shares of money market funds sold by the
distributor that were not acquired by exchange from other funds offered with a sales charge may not be combined.
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Certain exceptions may apply. Please contact your Service Agent for additional information.
Certain trustees and fiduciaries may be entitled to combine accounts in determining their sales charge.
Letter of Intent
Helps you take advantage of breakpoints in Class A sales charges. You may purchase Class A shares of funds sold by the distributor over a 13 month period and
pay the same sales charge, if any, as if all shares had been purchased at once. You have a choice of seven Asset Level Goal amounts, as follows:
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(1) $25,000
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(5) $500,000
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(2) $50,000
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(6) $750,000
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(3) $100,000
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(7) $1,000,000
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(4) $250,000
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Each time you make a Class A purchase under a Letter of Intent, you will be entitled to pay the
sales charge that is applicable to the amount of your Asset Level Goal. For example, if your Asset Level Goal is $100,000, any Class A investments you make under a Letter of Intent would be subject to the sales charge of the specific
fund you are investing in for purchases of $100,000. Sales charges and breakpoints vary among the funds sold by the distributor.
When you enter into a Letter of Intent, you agree to purchase in Eligible Accounts over a thirteen (13) month period Eligible Fund Purchases in an amount equal to the Asset Level Goal you
have selected, less any Eligible Prior Purchases. For this purpose, shares are valued at the public offering price (including any sales charge paid) calculated as of the date of purchase, plus any appreciation in the value of the shares as of the
date of calculation, except for Eligible Prior Purchases, which are valued at current value as of the date of calculation. Your commitment will be met if at any time during the 13-month period the value, as so determined, of eligible holdings is at
least equal to your Asset Level Goal. All reinvested dividends and distributions on shares acquired under the Letter will be credited towards your Asset Level Goal. You may include any Eligible Fund Purchases towards the Letter,
including shares of classes other than Class A shares. However, a Letter of Intent will not entitle you to a reduction in the sales charge payable on any shares other than Class A shares, and if the shares are subject to a contingent
deferred sales charge, you will still be subject to that contingent deferred sales charge with respect to those shares. You must make reference to the Letter of Intent each time you make a purchase under the Letter.
Eligible Fund Purchases.
Generally, any shares of a fund sold by the distributor may be credited towards your Asset
Level Goal. Shares of money market funds sold by the distributor acquired by exchange from other funds offered with a sales charge may be credited toward your Asset Level Goal.
The eligible funds may change from time to time. Investors should check with their Service Agent to see which funds may be eligible.
Eligible Accounts.
Purchases may be made through any account in your name, or in the name of your spouse or your
children under the age of 21. You may need to provide certain records, such as account statements, in order to verify your eligibility for reduced sales charges. Contact your Service Agent to see which accounts may be credited toward your Asset
Level Goal.
56
Eligible Prior Purchases.
You may also credit towards your Asset Level Goal
any Eligible Fund Purchases made in Eligible Accounts at any time prior to entering into the Letter of Intent that have not been sold or redeemed, based on the current price of those shares as of the date of calculation.
Increasing the Amount of the Letter of Intent.
You may at any time increase your Asset Level Goal. You must, however,
contact your Service Agent, or if you purchase your shares directly through the transfer agent, contact the transfer agent, prior to making any purchases in an amount in excess of your current Asset Level Goal. Upon such an increase, you will
be credited by way of additional shares at the then-current offering price for the difference between: (a) the aggregate sales charges actually paid for shares already purchased under the Letter of Intent and (b) the aggregate applicable
sales charges for the increased Asset Level Goal. The 13-month period during which the Asset Level Goal must be achieved will remain unchanged.
Sales and Exchanges.
Shares acquired pursuant to a Letter of Intent, other than Escrowed Shares as defined below, may be redeemed or exchanged at any time, although any shares that are
redeemed prior to meeting your Asset Level Goal will no longer count towards meeting your Asset Level Goal. However, complete liquidation of purchases made under a Letter of Intent prior to meeting the Asset Level Goal will result in
the cancellation of the Letter. See Failure to Meet Asset Level Goal below. Exchanges in accordance with the funds Prospectus are permitted, and shares so exchanged will continue to count towards your Asset Level Goal, as
long as the exchange results in an Eligible Fund Purchase.
Cancellation of Letter of Intent.
You may cancel
a Letter of Intent by notifying your Service Agent in writing, or if you purchase your shares directly through the transfer agent, by notifying the transfer agent in writing. The Letter will be automatically cancelled if all shares are sold or
redeemed as set forth above. See Failure to Meet Asset Level Goal below.
Escrowed Shares.
Shares
equal in value to five percent (5%) of your Asset Level Goal as of the date your Letter of Intent (or the date of any increase in the amount of the Letter) is accepted will be held in escrow during the term of your Letter. The Escrowed
Shares will be included in the total shares owned as reflected in your account statement and any dividends and capital gains distributions applicable to the Escrowed Shares will be credited to your account and counted towards your Asset
Level Goal or paid in cash upon request. The Escrowed Shares will be released from escrow if all the terms of your Letter are met.
Failure to Meet Asset Level Goal.
If the total assets under your Letter of Intent within its 13-month term are less than your Asset Level Goal whether because you made insufficient
Eligible Fund Purchases, redeemed all of your holdings or cancelled the Letter before reaching your Asset Level Goal, you will be liable for the difference between: (a) the sales charge actually paid and (b) the sales charge that
would have applied if you had not entered into the Letter. You may, however, be entitled to any breakpoints that would have been available to you under the accumulation privilege. An appropriate number of shares in your account will be redeemed to
realize the amount due. For these purposes, by entering into a Letter of Intent, you irrevocably appoint your Service Agent, or if you purchase your shares directly through the transfer agent, the transfer agent, as your attorney-in-fact for the
purposes of holding the Escrowed Shares and surrendering shares in your account for redemption. If there are insufficient assets in your account, you will be liable for the difference. Any Escrowed Shares remaining after such redemption will be
released to your account.
Contingent Deferred Sales Charge Provisions
Contingent deferred sales charge shares are: (a) Class C shares and (b) Class A shares that were purchased
without an initial sales charge but are subject to a contingent deferred sales charge. A contingent deferred sales charge may be imposed on certain redemptions of these shares.
Any applicable contingent deferred sales charge will be assessed on the NAV at the time of purchase or redemption whichever is less.
57
Class A shares that are contingent deferred sales charge shares are subject to a 1.00%
contingent deferred sales charge if redeemed within 18 months of purchase (or within 12 months for shares purchased prior to August 1, 2012). Class C shares that are contingent deferred sales charge shares are subject to a 1.00% contingent
deferred sales charge if redeemed within 12 months of purchase.
In determining the applicability of any contingent deferred
sales charge, it will be assumed that a redemption is made first of shares representing capital appreciation, next of shares representing the reinvestment of dividends and capital gain distributions, next of shares that are not subject to the
contingent deferred sales charge and finally of other shares held by the shareholder for the longest period of time. The length of time that contingent deferred sales charge shares acquired through an exchange have been held will be calculated from
the date the shares exchanged were initially acquired in one of the other funds sold by the distributor. For federal income tax purposes, the amount of the contingent deferred sales charge will reduce the gain or increase the loss, as the case may
be, on the amount realized on redemption. The funds distributor receives contingent deferred sales charges in partial consideration for its expenses in selling shares.
Waivers of Contingent Deferred Sales Charge
The
contingent deferred sales charge will be waived on: (a) exchanges (see Exchange Privilege); (b) automatic cash withdrawals in amounts equal to or less than 2.00% per month of the shareholders account balance at the
time the withdrawals commence, up to a maximum of 12.00% in one year (see Automatic Cash Withdrawal Plan); (c) redemptions of shares within 12 months following the death or disability (as defined in the Code) of the
shareholder; (d) mandatory post-retirement distributions from retirement plans or IRAs commencing on or after attainment of age 70
1
/
2
(except that shareholders who purchased shares subject to a contingent deferred sales
charge prior to May 23, 2005 will be grandfathered and will be eligible to obtain the waiver at
age 59
1
/
2
by demonstrating such eligibility at the time of redemption); (e) involuntary redemptions; (f) redemptions of shares to effect a combination of the fund with any investment company by merger,
acquisition of assets or otherwise; (g) tax-free returns of an excess contribution to any retirement plan; and (h) certain redemptions of shares of the fund in connection with lump-sum or other distributions made by eligible retirement
plans or redemption of shares by participants in certain wrap fee or asset allocation programs sponsored by broker/dealers and other financial institutions that have entered into agreements with the distributor or the manager.
The contingent deferred sales charge is waived on Class C shares purchased by retirement plan omnibus
accounts held on the books of the fund.
A shareholder who has redeemed shares from other funds sold by the distributor may,
under certain circumstances, reinvest all or part of the redemption proceeds within 60 days and receive pro rata credit for any contingent deferred sales charge imposed on the prior redemption.
Contingent deferred sales charge waivers will be granted subject to confirmation by the distributor or the transfer agent of the
shareholders status or holdings, as the case may be.
Grandfathered Retirement Program with Exchange Features
Certain retirement plan programs with exchange features in effect prior to November 20, 2006 (collectively, the Grandfathered
Retirement Program), that are authorized by the distributor to offer eligible retirement plan investors the opportunity to exchange all of their Class C shares for Class A shares of an applicable fund sold by the distributor, are
permitted to maintain such share class exchange feature for current and prospective retirement plan investors. Under the Grandfathered Retirement Program, Class C shares of the fund may be purchased by plans investing less than $3 million. Class C
shares are eligible for exchange into Class A shares not later than eight years after the plan joins the program. They are eligible for exchange in the following circumstances:
If a participating plans total Class C holdings in all non-money market funds sold by the distributor equal at least $3,000,000 at
the end of the fifth year after the date the participating plan enrolled in the Grandfathered
58
Retirement Program, the participating plan will be offered the opportunity to exchange all of its Class C shares for Class A shares of the fund. Such participating plans will be notified of
the pending exchange in writing within 30 days after the fifth anniversary of the enrollment date and, unless the exchange offer has been rejected in writing, the exchange will occur on or about the 90th day after the fifth anniversary date. If the
participating plan does not qualify for the five-year exchange to Class A shares, a review of the participating plans holdings will be performed each quarter until either the participating plan qualifies or the end of the eighth year.
Any participating plan that has not previously qualified for an exchange into Class A shares will be offered the
opportunity to exchange all of its Class C shares for Class A shares of the same fund regardless of asset size at the end of the eighth year after the date the participating plan enrolled in the Grandfathered Retirement Program. Such plans will
be notified of the pending exchange in writing approximately 60 days before the eighth anniversary of the enrollment date and, unless the exchange has been rejected in writing, the exchange will occur on or about the eighth anniversary date. Once an
exchange has occurred, a participating plan will not be eligible to acquire additional Class C shares, but instead may acquire Class A shares of the same fund. Any Class C shares not converted will continue to be subject to the distribution
fee.
For further information regarding this Program, contact your Service Agent or the transfer agent.
Participating plans that enrolled in the Grandfathered Retirement Program prior to June 2, 2003 should contact the transfer agent
for information regarding Class C exchange privileges applicable to their plan.
Determination of Public Offering Price
The fund offers its shares on a continuous basis. The public offering price for each class of shares of the fund is equal to the NAV per
share at the time of purchase, plus for Class A shares an initial sales charge based on the aggregate amount of the investment. The public offering price for Class C, Class FI, Class R, Class I and Class IS shares (and
Class A share purchases, including applicable rights of accumulation, equaling or exceeding $1,000,000) is equal to the NAV per share at the time of purchase and no sales charge is imposed at the time of purchase. A contingent deferred sales
charge, however, is imposed on certain redemptions of Class C shares, and on Class A shares when purchased in amounts equaling or exceeding $1,000,000.
Set forth below is an example of the method of computing the offering price of the Class A shares of the fund based on the NAV of a share of the fund as of
[ ], 2013.
|
|
|
|
|
Class A (based on an NAV of $[ ] and a maximum initial sales charge of
[ ]%)
|
|
$
|
[ ]
|
|
REDEMPTION OF SHARES
The right of redemption may be suspended or the date of payment postponed (a) for any period during which the NYSE is closed (other
than for customary weekend and holiday closings), (b) when trading in the markets the fund normally utilizes is restricted, or an emergency exists, as determined by the SEC, so that disposal of the funds investments or determination of
NAV is not reasonably practicable or (c) for such other periods as the SEC by order may permit for protection of the funds shareholders.
Redemption proceeds will be mailed to an investors address of record. The transfer agent may require additional supporting documents for redemptions made by corporations, executors, administrators,
trustees or guardians. A redemption request will not be deemed properly received until the transfer agent receives all required documents in proper form.
If a shareholder holds shares in more than one class, any request for redemption must specify the class being redeemed. In the event of a failure to specify which class, or if the investor owns fewer
shares of the class than
59
specified, the redemption request will be delayed until the transfer agent receives further instructions. The redemption proceeds will be remitted on or before the seventh business day following
receipt of proper tender, except on any days on which the NYSE is closed or as permitted under the 1940 Act, in extraordinary circumstances. Redemption proceeds for shares purchased by check, other than a certified or official bank check, will be
remitted upon clearance of the check, which may take up to ten days. Each Service Agent is responsible for transmitting promptly orders for its customers.
The Service Agent may charge you a fee for executing your order. The amount and applicability of such a fee is determined and disclosed to its customers by each Service Agent.
Additional Information Regarding Telephone Redemption and Exchange Program.
Neither the fund nor its agents will be liable
for following instructions communicated by telephone that are reasonably believed to be genuine. The fund and its agents will employ procedures designed to verify the identity of the caller and legitimacy of instructions (for example, a
shareholders name and account number will be required and phone calls may be recorded). The fund reserves the right to suspend, modify or discontinue the telephone redemption and exchange program or to impose a charge for this service at any
time following at least seven (7) days prior notice to shareholders.
Automatic Cash Withdrawal Plan
An automatic cash withdrawal plan (the Withdrawal Plan) is available to shareholders as described in the Prospectus. To the
extent withdrawals under the Withdrawal Plan exceed dividends, distributions and appreciation of a shareholders investment in the fund, there will be a reduction in the value of the shareholders investment, and continued withdrawal
payments may reduce the shareholders investment and ultimately exhaust it. Withdrawal payments should not be considered as income from investment in the fund. The Withdrawal Plan will be carried over on exchanges between funds sold by the
distributor or classes of the fund. All dividends and distributions on shares in the Withdrawal Plan are reinvested automatically at NAV in additional shares of the fund.
For additional information, shareholders should contact their Service Agent. A shareholder who purchases shares
directly through the transfer agent may continue to do so and applications for participation in the Withdrawal Plan should be sent to the transfer agent. Withdrawals may be scheduled on any day of the month; however, if the shareholder does not
specify a day, the transfer agent will schedule the withdrawal on the 25
th
day (or the next business day if the 25
th
day is a weekend or holiday) of the month.
Distributions in Kind
If a funds manager determines that it would not be in the best interests of the funds remaining shareholders to make a
redemption payment wholly in cash, the fund may honor a redemption request by delivering portfolio securities to a shareholder to pay all or a portion of the redemption proceeds. However, the fund will not use securities to satisfy any request for
redemption, or combination of requests from the same shareholder in any 90-day period, if the total redemption amount does not exceed $250,000 or 1% of the net assets of the fund, whichever is less. When a redemption is paid in kind, the
securities distributed to the redeeming shareholder will be valued in accordance with the procedures described under Share price in the funds Prospectus. Because a redemption in-kind may be used during times when the markets
experience increased illiquidity, these valuation methods may include fair value estimations and a shareholder may have difficulty selling those securities at the valuation price. A shareholder receiving securities from a fund may incur costs in
holding and when subsequently selling those securities, and the market price of those securities will be subject to fluctuation until they are sold. A fund will not use securities to pay redemptions by LMIS or other affiliated persons of the fund,
except as permitted by law, SEC rules or orders, or interpretive guidance from the SEC staff or other proper authorities
60
EXCHANGE PRIVILEGE
The exchange privilege enables shareholders to acquire shares of the same class in another fund sold by the distributor. This privilege
is available to shareholders residing in any state in which the fund shares being acquired may legally be sold. Prior to any exchange, the shareholder should obtain and review a copy of the current prospectus of each fund into which an exchange is
being considered. Prospectuses may be obtained from a Service Agent.
Upon receipt of proper instructions and all necessary
supporting documents, shares submitted for exchange are redeemed at the then-current NAV, and the proceeds are immediately invested in shares of the fund being acquired at that funds then current NAV. The distributor reserves the right to
reject any exchange request. The exchange privilege may be modified or terminated at any time after written notice to shareholders.
Class A, Class FI, Class R, Class I and Class IS Exchanges.
Class A, Class FI, Class R, Class I and Class IS shareholders of the fund who wish to exchange all or a portion of their shares
for shares of the respective class in another fund may do so without imposition of any charge.
Class C Exchanges.
Class C shares of the fund may be exchanged for other Class C shares without a contingent deferred sales charge. Upon an exchange, the new Class C shares will be deemed to have been purchased on the same date as the Class C shares of the fund that
have been exchanged.
Additional Information Regarding the Exchange Privilege
The fund is not designed to provide investors with a means of speculation on short-term market movements. A pattern of frequent exchanges
by investors can be disruptive to efficient portfolio management and, consequently, can be detrimental to the fund and its shareholders. See Frequent trading of fund shares in the Prospectus.
During times of drastic economic or market conditions, the fund may suspend the exchange privilege temporarily without notice and treat
exchange requests based on their separate componentsredemption orders with a simultaneous request to purchase the other funds shares. In such a case, the redemption request would be processed at the funds next determined NAV but
the purchase order would be effective only at the NAV next determined after the fund being purchased formally accepts the order, which may result in the purchase being delayed.
Certain shareholders may be able to exchange shares by telephone. See the funds Prospectus for additional information. Exchanges
will be processed at the NAV next determined. Redemption procedures discussed above are also applicable for exchanging shares, and exchanges will be made upon receipt of all supporting documents in proper form. If the account registration of the
shares of the fund being acquired is identical to the registration of the shares of the fund exchanged, no signature guarantee is required.
This exchange privilege may be modified or terminated at any time, and is available only in those jurisdictions where such exchanges legally may be made. Before making any exchange, shareholders should
contact the transfer agent or, if they hold fund shares through a Service Agent, their Service Agent, to obtain more information and prospectuses of the funds to be acquired through the exchange. An exchange is treated as a sale of the shares
exchanged and could result in taxable gain or loss to the shareholder making the exchange.
VALUATION OF SHARES
The NAV per share of each class is calculated on each day, Monday through Friday, except days on which the NYSE is closed. As of the date of this SAI, the NYSE is normally open for trading every weekday
except in
61
the event of an emergency or for the following holidays (or the days on which they are observed): New Years Day, Martin Luther King, Jr. Day, Presidents Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. Because of the differences in distribution fees and class-specific expenses, the per share NAV of each class will differ. Please see the Prospectus for a description of the
procedures used by the fund in valuing its assets.
PORTFOLIO TRANSACTIONS
Subject to such policies as may be established by the Board from time to time, the subadviser is primarily responsible for the
funds portfolio decisions and the placing of the funds portfolio transactions and Western Asset manages the cash and short-term instruments of the fund.
The cost of securities purchased from underwriters includes an underwriting commission, concession or a net price. Debt securities purchased and sold by the fund generally are traded on a net basis (i.e.,
without a commission) through dealers acting for their own account and not as brokers, or otherwise involve transactions directly with the issuer of the instrument. This means that a dealer makes a market for securities by offering to buy at one
price and selling the security at a slightly higher price. The difference between the prices is known as a spread. Other portfolio transactions may be executed through brokers acting as agents. The fund will pay a spread or commission in
connection with such transactions. Commissions are negotiated with brokers on such transactions.
Pursuant to the Subadvisory
Agreement, the subadviser is authorized to place orders pursuant to its investment determinations for the fund either directly with the issuer or with any broker or dealer, foreign currency dealer, futures commission merchant or others selected by
it. The general policy of the subadviser in selecting brokers and dealers is to obtain the best results achievable in the context of a number of factors which are considered both in relation to individual trades and broader trading patterns,
including the reliability of the broker/dealer, the competitiveness of the price and the commission, the research services received and whether the broker/dealer commits its own capital.
In connection with the selection of such brokers or dealers and the placing of such orders, subject to applicable law, brokers or dealers
may be selected who also provide brokerage and research services (as those terms are defined in Section 28(e) of the 1934 Act) to the fund and/or the other accounts over which the subadviser or its affiliates exercise investment discretion. The
subadviser is authorized to pay a broker or dealer that provides such brokerage and research services a commission for executing a portfolio transaction for the fund which is in excess of the amount of commission another broker or dealer would have
charged for effecting that transaction if the subadviser determines in good faith that such amount of commission is reasonable in relation to the value of the brokerage and research services provided by such broker or dealer. Investment research
services include information and analysis on particular companies and industries as well as market or economic trends and portfolio strategy, market quotations for portfolio evaluations, analytical software and similar products and services. If a
research service also assists the subadviser in a non-research capacity (such as bookkeeping or other administrative functions), then only the percentage or component that provides assistance to the subadviser in the investment decision making
process may be paid in commission dollars. This determination may be viewed in terms of either that particular transaction or the overall responsibilities that the subadviser and its affiliates have with respect to accounts over which they exercise
investment discretion. The subadviser may also have arrangements with brokers pursuant to which such brokers provide research services to the subadviser in exchange for a certain volume of brokerage transactions to be executed by such brokers. While
the payment of higher commissions increases the funds costs, the subadviser does not believe that the receipt of such brokerage and research services significantly reduces its expenses as subadviser. Arrangements for the receipt of research
services from brokers may create conflicts of interest.
Research services furnished to the subadviser by brokers that effect
securities transactions for the fund may be used by the subadviser in servicing other investment companies and accounts which the subadviser manages.
62
Similarly, research services furnished to the subadviser by brokers that effect securities transactions for other investment companies and accounts which the subadviser manages may be used by the
subadviser in servicing the fund. Not all of these research services are used by the subadviser in managing any particular account, including the fund.
As the fund commenced operations on [ ], 2013, the fund paid no commissions on brokerage transactions directed to brokers because of
research services provided as of the date of this SAI.
The fund contemplates that, consistent with the policy of obtaining
the best net results, brokerage transactions may be conducted through affiliated broker/dealers, as defined in the 1940 Act. The funds Board has adopted procedures in accordance with Rule 17e-1 under the 1940 Act to ensure that all
brokerage commissions paid to such affiliates are reasonable and fair in the context of the market in which such affiliates operate.
As the fund commenced operations on [ ], 2013, the fund paid no commissions for brokerage transactions as of the date of this SAI.
In certain instances there may be securities that are suitable as an investment for the fund as well as for one or more of
the other clients of the subadviser. Investment decisions for the fund and for the subadvisers other clients are made with a view to achieving their respective investment objectives. It may develop that a particular security is bought or sold
for only one client even though it might be held by, or bought or sold for, other clients. Likewise, a particular security may be bought for one or more clients when one or more clients are selling the same security. Some simultaneous transactions
are inevitable when several clients receive investment advice from the same investment adviser, particularly when the same security is suitable for the investment objectives of more than one client. When two or more clients are simultaneously
engaged in the purchase or sale of the same security, the securities are allocated among clients in a manner believed to be equitable to each. It is recognized that in some cases this system could adversely affect the price of or the size of the
position obtainable in a security for the fund. When purchases or sales of the same security for the fund and for other portfolios managed by the subadviser occur contemporaneously, the purchase or sale orders may be aggregated in order to obtain
any price advantages available to large volume purchases or sales.
As the fund commenced operations on
[ ], 2013, the fund did not hold securities issued by its regular broker/dealers as of the date of this SAI.
DISCLOSURE OF PORTFOLIO HOLDINGS
The funds Board has adopted policies and procedures (the policy) developed by the manager with respect to the
disclosure of the funds portfolio securities and any ongoing arrangements to make available information about the funds portfolio securities. The manager believes the policy is in the best interests of the fund and its shareholders and
that it strikes an appropriate balance between the desire of investors for information about fund portfolio holdings and the need to protect funds from potentially harmful disclosures.
General rules/Website disclosure
The policy provides that information
regarding a funds portfolio holdings may be shared at any time with employees of the manager, a funds subadviser and other affiliated parties involved in the management, administration or operations of the fund (referred to as
fund-affiliated personnel). With respect to non-money market funds, a funds complete list of holdings (including the size of each position) may be made available to investors, potential investors, third parties and Legg Mason personnel that
are not fund-affiliated personnel (i) upon the filing of Form N-Q or Form N-CSR in accordance with SEC rules, provided that such filings are not made until 15 calendar days following the end of the period covered by the Form N-Q or Form N-CSR
or (ii) no
63
sooner than 15 days after month end, provided that such information has been made available through public disclosure at least one day previously. Typically, public disclosure is achieved by
required filings with the SEC and/or posting the information to Legg Masons or the funds Internet site that is accessible by the public, or through public release by a third party vendor.
The fund currently discloses its complete portfolio holdings 14 calendar days after quarter-end on Legg Masons website:
http://www.leggmason.com/individualinvestors/prospectuses (click on the name of the fund).
Ongoing arrangements
Under the policy, a fund may release portfolio holdings information on a regular basis to a custodian, sub-custodian, fund accounting
agent, proxy voting provider, rating agency or other vendor or service provider for a legitimate business purpose, where the party receiving the information is under a duty of confidentiality, including a duty to prohibit the sharing of non-public
information with unauthorized sources and trading upon non-public information. A fund may enter into other ongoing arrangements for the release of portfolio holdings information, but only if such arrangements serve a legitimate business purpose and
are with a party who is subject to a confidentiality agreement and restrictions on trading upon non-public information. None of the funds, Legg Mason or any other affiliated party may receive compensation or any other consideration in connection
with such arrangements. Ongoing arrangements to make available information about a funds portfolio securities will be reviewed at least annually by the funds board.
Set forth below is a list, as of September 30, 2012, of those parties with whom the manager, on behalf of each fund, has authorized
ongoing arrangements that include the release of portfolio holdings information in accordance with the policy, as well as the frequency of the release under such arrangements, and the length of the lag, if any, between the date of the information
and the date on which the information is disclosed. The parties identified below as recipients are service providers, fund rating agencies, consultants and analysts.
|
|
|
|
|
Recipient
|
|
Frequency
|
|
Delay Before Dissemination
|
State Street Bank and Trust Company
(Fund Custodian and Accounting Agent).
|
|
Daily
|
|
None
|
A.S.A.P. Advisor Services, Inc.
|
|
Quarterly
|
|
8-10 Days after Quarter-End
|
Bloomberg L.P.
|
|
Quarterly
|
|
Sent 6 Business Days after Quarter-End
|
Lipper Analytical Services Corp.
|
|
Quarterly
|
|
Sent 6 Business Days after Quarter-End
|
Morningstar
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
|
Institutional Shareholder Services
(Proxy Voting Services)
|
|
As necessary
|
|
None
|
Thomson/Vestek
|
|
Daily
|
|
None
|
FactSet
|
|
Daily
|
|
None
|
The Bank of New York Mellon
|
|
Daily
|
|
None
|
Thomson
|
|
Semi-annually
|
|
None
|
SunGard/Protegent (formerly Dataware)
|
|
Daily
|
|
None
|
ITG
|
|
Daily
|
|
None
|
The Northern Trust Company
|
|
Daily
|
|
None
|
Middle Office Solutions, LLC
|
|
Daily
|
|
None
|
NaviSite, Inc.
|
|
Daily
|
|
None
|
Portfolio holdings information for a fund may also be released from time to time pursuant to ongoing
arrangements with the following parties:
|
|
|
|
|
Recipient
|
|
Frequency
|
|
Delay Before Dissemination
|
Baseline
|
|
Daily
|
|
None
|
Frank Russell
|
|
Monthly
|
|
1 Day
|
64
|
|
|
|
|
Recipient
|
|
Frequency
|
|
Delay Before Dissemination
|
Callan Associates
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
|
Mercer LLC
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
|
eVestment Alliance
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
|
Rogerscasey
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
|
Cambridge Associates LLC
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
|
Wilshire Associates Inc.
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
|
Informa Investment Solutions
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
|
Prima Capital
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
|
Investor Tools
|
|
Daily
|
|
None
|
Advent
|
|
Daily
|
|
None
|
BARRA
|
|
Daily
|
|
None
|
Plexus
|
|
Quarterly (Calendar)
|
|
Sent 1-3 Business Days after Quarter-End
|
Elkins/McSherry
|
|
Quarterly (Calendar)
|
|
Sent 1-3 Business Days after Quarter-End
|
Quantitative Services Group
|
|
Daily
|
|
None
|
Deutsche Bank
|
|
Monthly
|
|
6-8 Business Days
|
Fitch
|
|
Monthly
|
|
6-8 Business Days
|
Liberty Hampshire
|
|
Weekly and Month End
|
|
None
|
SunTrust
|
|
Weekly and Month End
|
|
None
|
S&P (Rating Agency)
|
|
Weekly Tuesday Night
|
|
1 Business Day
|
Electra Information Systems
|
|
Daily
|
|
None
|
Cabot Research
|
|
Weekly
|
|
None
|
Goldman Sachs
|
|
Daily
|
|
None
|
Chicago Mercantile Exchange
|
|
Daily
|
|
None
|
Canterbury Consulting
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
|
Broadridge
|
|
Daily
|
|
None
|
DST Global Solutions Limited
|
|
Monthly
|
|
Sent 6 Business Days after Month-End
|
Interactive Data Corp
|
|
Daily
|
|
None
|
Citigroup Global Markets Inc
|
|
Daily
|
|
None
|
Glass Lewis & Co
|
|
Daily
|
|
None
|
Fidelity
|
|
Quarterly
|
|
5 Business Days
|
Excluded from the lists of ongoing arrangements set forth above are ongoing arrangements where either
(i) the disclosure of portfolio holdings information occurs concurrently with or after the time at which the portfolio holdings information is included in a public filing with the SEC that is required to include the information, or (ii) a
funds portfolio holdings information is made available no earlier than the day next following the day on which the fund makes the information available on its website, as disclosed in the funds prospectus. The approval of the funds
Chief Compliance Officer, or designee, must be obtained before entering into any new ongoing arrangement or altering any existing ongoing arrangement to make available portfolio holdings information, or with respect to any exceptions from the
policy.
Release of limited portfolio holdings information
In addition to the ongoing arrangements described above, a funds complete or partial list of holdings (including size of positions) may be released to another party on a one-time basis, provided the
party receiving the information has executed a non-disclosure and confidentiality agreement and provided that the specific release of information has been approved by the funds Chief Compliance Officer or designee as consistent with the
policy. By way of illustration and not of limitation, release of non-public information about a funds portfolio holdings may be made (i) to a proposed or potential adviser or subadviser or other investment manager asked to provide
investment management services to the fund, or (ii) to a third party in connection with a program or similar trade.
65
In addition, the policy permits the release to investors, potential investors, third parties
and Legg Mason personnel that are not fund-affiliated personnel of limited portfolio holdings information in other circumstances, including:
|
1.
|
A funds top ten securities, current as of month-end, and the individual size of each such security position may be released at any time following month-end with
simultaneous public disclosure.
|
|
2.
|
A funds top ten securities positions (including the aggregate but not individual size of such positions) may be released at any time with simultaneous public
disclosure.
|
|
3.
|
A list of securities (that may include fund holdings together with other securities) followed by an investment professional (without position sizes or identification of
particular funds) may be disclosed to sell-side brokers at any time for the purpose of obtaining research and/or market information from such brokers.
|
|
4.
|
A trade in process may be discussed only with counterparties, potential counterparties and others involved in the transaction (
i.e
., brokers and custodians).
|
|
5.
|
A funds sector weightings, yield and duration (for fixed income and money market funds), performance attribution (
e.g
., analysis of the funds
out-performance or underperformance of its benchmark based on its portfolio holdings) and other summary and statistical information that does not include identification of specific portfolio holdings may be released, even if non-public, if such
release is otherwise in accordance with the policys general principles.
|
|
6.
|
A small number of a funds portfolio holdings (including information that the fund no longer holds a particular holding) may be released, but only if the release
of the information could not reasonably be seen to interfere with current or future purchase or sales activities of the fund and is not contrary to law.
|
|
7.
|
A funds portfolio holdings may be released on an as-needed basis to its legal counsel, counsel to its independent trustees and its independent public accounting
firm, in required regulatory filings or otherwise to governmental agencies and authorities.
|
Exceptions to the policy
A funds Chief Compliance Officer, or designee, may, as is deemed appropriate, approve exceptions from the policy.
Exceptions are granted only after a thorough examination and consultation with the managers legal department, as necessary. Exceptions from the policy are reported annually to each funds board.
Limitations of policy
The funds portfolio holdings policy is designed to prevent sharing of portfolio information with third parties that have no
legitimate business purpose for accessing the information. The policy may not be effective to limit access to portfolio holdings information in all circumstances, however. For example, the manager or a subadviser may manage accounts other than a
fund that have investment objectives and strategies similar to those of the fund. Because these accounts, including a fund, may be similarly managed, portfolio holdings may be similar across the accounts. In that case, an investor in another account
managed by the manager or a subadviser may be able to infer the portfolio holdings of the fund from the portfolio holdings in that investors account.
THE TRUST
The Trust.
The fund is a series of Legg Mason Partners Equity Trust (referred to in this section as the trust), a Maryland statutory
trust. The certificate of trust to establish the trust was filed with the State of Maryland on October 4, 2006.
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A Maryland statutory trust is an unincorporated business association that is established
under, and governed by, Maryland law. Maryland law provides a statutory framework for the powers, duties, rights and obligations of the Board (referred to in this section as the trustees) and shareholders of a trust, while the more
specific powers, duties, rights and obligations of the trustees and the shareholders are determined by the trustees as set forth in a trusts declaration of trust (referred to in this section as the declaration). Some of the more
significant provisions of the declaration are described below.
Shareholder Voting.
The declaration provides for shareholder voting as required by the 1940 Act or other applicable laws but otherwise permits, consistent
with Maryland law, actions by the trustees without seeking the consent of shareholders. The trustees may, without shareholder approval, amend the declaration or authorize the merger or consolidation of the trust into another trust or entity,
reorganize the trust, or any series or class into another trust or entity or a series or class of another entity, sell all or substantially all of the assets of the trust or any series or class to another entity, or a series or class of another
entity, or terminate the trust or any series or class.
The fund is not required to hold an annual meeting of shareholders,
but the fund will call special meetings of shareholders whenever required by the 1940 Act or by the terms of the declaration. The declaration provides for dollar-weighted voting which means that a shareholders voting power is
determined, not by the number of shares he or she owns, but by the dollar value of those shares determined on the record date. All shareholders of record of all series and classes of the trust vote together, except where required by the 1940 Act to
vote separately by series or by class, or when the trustees have determined that a matter affects only the interests of one or more series or classes of shares.
Election and Removal of Trustees.
The declaration provides that the
trustees may establish the number of trustees and that vacancies on the Board may be filled by the remaining trustees, except when election of trustees by the shareholders is required under the 1940 Act. Trustees are then elected by a plurality of
votes cast by shareholders at a meeting at which a quorum is present. The declaration also provides that a mandatory retirement age may be set by action of two-thirds of the trustees and that trustees may be removed, with or without cause, by a vote
of shareholders holding two-thirds of the voting power of the trust, or by a vote of two-thirds of the remaining trustees. The provisions of the declaration relating to the election and removal of trustees may not be amended without the approval of
two-thirds of the trustees.
Amendments to the Declaration.
The trustees are authorized to amend the declaration without the vote of shareholders, but no amendment may be made that impairs the exemption from personal liability granted in the declaration to persons
who are or have been shareholders, trustees, officers or employees of the trust, or that limits the rights to indemnification or insurance provided in the declaration with respect to actions or omissions of persons entitled to indemnification under
the declaration prior to the amendment.
Issuance and Redemption of Shares.
The fund may issue an unlimited number of shares for such consideration and on such terms as the trustees may determine. Shareholders are
not entitled to any appraisal, preemptive, conversion, exchange or similar rights, except as the trustees may determine. The fund may involuntarily redeem a shareholders shares upon certain conditions as may be determined by the trustees,
including, for example, if the shareholder fails to provide the fund with identification required by law, or if the fund is unable to verify the information received from the shareholder. Additionally, as discussed below, shares may be redeemed in
connection with the closing of small accounts.
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Disclosure of Shareholder Holdings.
The declaration specifically requires shareholders, upon demand, to disclose to the fund information with respect to the direct and
indirect ownership of shares in order to comply with various laws or regulations, and the fund may disclose such ownership if required by law or regulation, or as the trustees otherwise decide.
Small Accounts.
The
declaration provides that the fund may close out a shareholders account by redeeming all of the shares in the account if the account falls below a minimum account size (which may vary by class) that may be set by the trustees from time to
time. Alternately, the declaration permits the fund to assess a fee for small accounts (which may vary by class) and redeem shares in the account to cover such fees, or convert the shares into another share class that is geared to smaller accounts.
Series and Classes.
The declaration provides that the trustees may establish series and classes in addition to those currently established and to determine the rights and preferences, limitations and restrictions, including
qualifications for ownership, conversion and exchange features, minimum purchase and account size, expenses and charges, and other features of the series and classes. The trustees may change any of those features, terminate any series or class,
combine series with other series in the trust, combine one or more classes of a series with another class in that series or convert the shares of one class into shares of another class.
Each share of the fund, as a series of the trust, represents an interest in the fund only and not in the assets of any other series of
the trust.
Shareholder, Trustee and Officer Liability.
The declaration provides that shareholders are not personally liable for the obligations of the fund and requires the fund to indemnify a shareholder against any loss or expense arising from any such
liability. The fund will assume the defense of any claim against a shareholder for personal liability at the request of the shareholder. The declaration further provides that a trustee acting in his or her capacity of trustee is not personally
liable to any person, other than the trust or its shareholders, in connection with the affairs of the trust. Each trustee is required to perform his or her duties in good faith and in a manner he or she believes to be in the best interests of the
trust. All actions and omissions of trustees are presumed to be in accordance with the foregoing standard of performance, and any person alleging the contrary has the burden of proving that allegation.
The declaration limits a trustees liability to the trust or any shareholder to the full extent permitted under current Maryland law
by providing that a trustee is liable to the trust or its shareholders for monetary damages only (a) to the extent that it is proved that he or she actually received an improper benefit or profit in money, property or services or (b) to
the extent that a judgment or other final adjudication adverse to the trustee is entered in a proceeding based on a finding in the proceeding that the trustees action, or failure to act, was the result of active and deliberate dishonesty and
was material to the cause of action adjudicated in the proceeding. The declaration requires the trust to indemnify any persons who are or who have been trustees, officers or employees of the trust to the fullest extent permitted by law against
liability and expenses in connection with any claim or proceeding in which he or she is involved by virtue of having been a trustee, officer or employee. In making any determination as to whether any person is entitled to the advancement of expenses
in connection with a claim for which indemnification is sought, such person is entitled to a rebuttable presumption that he or she did not engage in conduct for which indemnification is not available.
The declaration provides that any trustee who serves as chair of the Board or of a committee of the Board, lead independent trustee or
audit committee financial expert, or in any other similar capacity will not be subject to any greater standard of care or liability because of such position.
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Derivative Actions.
The declaration provides a detailed process for the bringing of derivative actions by shareholders in order to permit legitimate inquiries and claims while avoiding the time, expense, distraction and
other harm that can be caused to the fund or its shareholders as a result of spurious shareholder demands and derivative actions. Prior to bringing a derivative action, a demand by three unrelated shareholders must be made on the trustees. The
declaration details information, certifications, undertakings and acknowledgements that must be included in the demand. The trustees are not required to consider a demand that is not submitted in accordance with the requirements contained in the
declaration. The declaration also requires that in order to bring a derivative action, the complaining shareholders must be joined in the action by shareholders owning, at the time of the alleged wrongdoing, at the time of demand, and at the time
the action is commenced, shares representing at least 5% of the voting power of the affected fund. The trustees have a period of 90 days, which may be extended by an additional 60 days, to consider the demand. If a majority of the trustees who are
considered independent for the purposes of considering the demand determine that a suit should be maintained, then the trust will commence the suit and the suit will proceed directly and not derivatively. If a majority of the independent trustees
determines that maintaining the suit would not be in the best interests of the fund, the trustees are required to reject the demand and the complaining shareholders may not proceed with the derivative action unless the shareholders are able to
sustain the burden of proof to a court that the decision of the trustees not to pursue the requested action was not consistent with the standard of performance required of the trustees in performing their duties. If a demand is rejected, the
complaining shareholders will be responsible for the costs and expenses (including attorneys fees) incurred by the trust in connection with the consideration of the demand if, in the judgment of the independent trustees, the demand was made
without reasonable cause or for an improper purpose. If a derivative action is brought in violation of the declaration, the shareholders bringing the action may be responsible for the funds costs, including attorneys fees.
The declaration further provides that the fund shall be responsible for payment of attorneys fees and legal expenses incurred by a
complaining shareholder only if required by law, and any attorneys fees that the fund are obligated to pay shall be calculated using reasonable hourly rates. The declaration also requires that actions by shareholders against the fund be
brought only in federal court in Baltimore, Maryland, or if not permitted to be brought in federal court, then in state court in Baltimore, Maryland, and that the right to jury trial be waived to the full extent permitted by law.
TAXES
The following is a summary of certain material U.S. federal income tax considerations regarding the purchase, ownership and disposition of shares of the fund by U.S. persons. This summary does not address
all of the potential U.S. federal income tax consequences that may be applicable to the fund or to all categories of investors, some of which may be subject to special tax rules. Current and prospective shareholders are urged to consult their own
tax advisers with respect to the specific federal, state, local and foreign tax consequences of investing in the fund. The summary is based on the laws in effect on the date of this SAI and existing judicial and administrative interpretations
thereof, all of which are subject to change, possibly with retroactive effect.
The Fund and Its Investments
The fund intends to continue to qualify to be treated as a regulated investment company under the Code each taxable year. To so qualify,
the fund must, among other things: (a) derive at least 90% of its gross income in each taxable year from dividends, interest, payments with respect to securities loans, gains from the sale or other disposition of stock, securities or foreign
currencies, other income (including, but not limited to, gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies and net income derived from interests in
qualified publicly traded partnerships (
i
.
e
., partnerships that are traded on an established securities market or tradable on a secondary market, other than partnerships that
69
derive 90% of their income from interest, dividends, capital gains and other traditionally permitted mutual fund income); and (b) diversify its holdings so that, at the end of each quarter
of the funds taxable year, (i) at least 50% of the market value of the funds assets is represented by cash, securities of other regulated investment companies, U.S. government securities and other securities, with such other
securities limited, in respect of any one issuer, to an amount not greater than 5% of the funds assets and not greater than 10% of the outstanding voting securities of such issuer and (ii) not more than 25% of the value of its assets is
invested in the securities (other than U.S. government securities or securities of other regulated investment companies) of any one issuer, any two or more issuers of which 20% or more of the voting stock is held by the fund and that are determined
to be engaged in the same or similar trades or businesses or related trades or businesses or in the securities of one or more qualified publicly traded partnerships.
The fund may be able to cure a failure to derive 90% of its income from the sources specified above or a failure to diversify its holdings in the manner described above by paying a tax, by disposing of
certain assets, or by paying a tax and disposing of assets. If, in any taxable year, the fund fails one of these tests and does not timely cure the failure, the fund will be taxed in the same manner as an ordinary corporation and distributions to
its shareholders will not be deductible by the fund in computing its taxable income.
Although in general the passive loss
rules of the Code do not apply to regulated investment companies, such rules do apply to a regulated investment company with respect to items attributable to interests in qualified publicly traded partnerships (
i.e.
, partnerships
that are traded on an established securities market or tradable on a secondary market, other than partnerships that derive 90% of their income from interest, dividends, capital gains, and other traditionally permitted mutual fund income). Fund
investments in partnerships, including in qualified publicly traded partnerships, may result in the fund being subject to state, local or foreign income, franchise or withholding tax liabilities.
As a regulated investment company, the fund will not be subject to U.S. federal income tax on its net investment income (
i.e.
,
income other than its net realized long-term and short-term capital gains) and its net realized long-term and short-term capital gains, if any, that it distributes to its shareholders, provided an amount equal to at least (i) 90% of the sum of
its investment company taxable income (
i.e.
, its taxable income minus the excess, if any, of its net realized long-term capital gains over its net realized short-term capital losses (including any capital loss carryovers), plus or minus
certain other adjustments as specified in the Code) and (ii) 90% of its net tax-exempt income for the taxable year is distributed to its shareholders in compliance with the Codes timing and other requirements. However, any taxable income
or gain the fund does not distribute will be subject to tax at regular corporate rates.
The Code imposes a 4% nondeductible
excise tax on the fund to the extent it does not distribute by the end of any calendar year at least 98% of its ordinary income for that year and at least 98.2% of its capital gain net income (both long-term and short-term) for the one-year period
ending, as a general rule, on October 31 of that year. For this purpose, however, any ordinary income or capital gain net income retained by the fund that is subject to corporate income tax will be considered to have been distributed by
year-end. In addition, the minimum amounts that must be distributed in any year to avoid the excise tax will be increased or decreased to reflect any underdistribution or overdistribution, as the case may be, from the previous year. The fund
anticipates that it will pay such dividends and will make such distributions as are necessary in order to avoid the application of this excise tax.
If, in any taxable year, the fund fails to qualify as a regulated investment company under the Code or fails to meet the distribution requirement, it will be taxed in the same manner as an ordinary
corporation and distributions to its shareholders will not be deductible by the fund in computing its taxable income. In addition, in the event of a failure to qualify, the funds distributions, to the extent derived from the funds
current or accumulated earnings and profits, will constitute dividends that are taxable to shareholders as ordinary income, even though those distributions might otherwise (at least in part) have been treated in the shareholders hands as
long-term capital gains. However, such dividends will be eligible (i) to be treated as qualified dividend income in
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the case of shareholders taxed as individuals and (ii) for the dividends received deduction in the case of corporate shareholders. Moreover, if the fund fails to qualify as a regulated
investment company in any year, it must pay out its earnings and profits accumulated in that year in order to qualify again as a regulated investment company. If the fund fails to qualify as a regulated investment company for a period greater than
two taxable years, the fund may be required to recognize any net built -in gains with respect to certain of its assets (
i.e
., the excess of the aggregate gains, including items of income, over aggregate losses that would have been realized
with respect to such assets if the fund had been liquidated) in order to qualify as a regulated investment company in a subsequent year.
The funds transactions in foreign currencies, forward contracts, options and futures contracts (including options and futures contracts on foreign currencies) will be subject to special provisions
of the Code (including provisions relating to hedging transactions and straddles) that, among other things, may affect the character of gains and losses realized by the fund (
i.e
., may affect whether gains or losses
are ordinary or capital), accelerate recognition of income to the fund and defer fund losses. These rules could therefore affect the character, amount and timing of distributions to shareholders. These provisions also (a) will require the fund
to mark-to-market certain types of the positions in its portfolio (
i.e
., treat them as if they were closed out at the end of each year) and (b) may cause the fund to recognize income without receiving cash with which to pay dividends or
make distributions in amounts necessary to satisfy the distribution requirements for avoiding income and excise taxes. The fund will monitor its transactions, will make the appropriate tax elections and will make the appropriate entries in its books
and records when it acquires any foreign currency, forward contract, option, futures contract or hedged investment in order to mitigate the effect of these rules and prevent disqualification of the fund as a regulated investment company.
The funds investments in so-called section 1256 contracts, such as regulated futures contracts, most foreign currency
forward contracts traded in the interbank market and options on most stock indexes, are subject to special tax rules. All section 1256 contracts held by the fund at the end of its taxable year are required to be marked to their market value, and any
unrealized gain or loss on those positions will be included in the funds income as if each position had been sold for its fair market value at the end of the taxable year. The resulting gain or loss will be combined with any gain or loss
realized by the fund from positions in section 1256 contracts closed during the taxable year. Provided such positions were held as capital assets and were not part of a hedging transaction nor part of a straddle, 60% of the
resulting net gain or loss will be treated as long-term capital gain or loss, and 40% of such net gain or loss will be treated as short-term capital gain or loss, regardless of the period of time the positions were actually held by the fund.
As a result of entering into swap contracts, the fund may make or receive periodic net payments. The fund may also make or
receive a payment when a swap is terminated prior to maturity through an assignment of the swap or other closing transaction. Periodic net payments will generally constitute ordinary income or deductions, while termination of a swap will generally
result in capital gain or loss (which will be a long-term capital gain or loss if the fund has been a party to the swap for more than one year). With respect to certain types of swaps, the fund may be required to currently recognize income or loss
with respect to future payments on such swaps or may elect under certain circumstances to mark such swaps to market annually for tax purposes as ordinary income or loss.
The fund may be required to treat amounts as taxable income or gain, subject to the distribution requirements referred to above, even though no corresponding amounts of cash are received concurrently, as
a result of (1) mark-to-market, constructive sale or rules applicable to PFICs (as defined below) or partnerships or trusts in which the fund invests or to certain options, futures or forward contracts, or appreciated financial
positions or (2) the inability to obtain cash distributions or other amounts due to currency controls or restrictions on repatriation imposed by a foreign country with respect to the funds investments (including through depositary
receipts) in issuers in such country or (3) tax rules applicable to debt obligations acquired with original issue discount, including zero-coupon or deferred payment bonds and pay-in-kind debt obligations, or to market discount if
an election is made with respect to such market discount. The fund may therefore be required to
71
obtain cash to be used to satisfy these distribution requirements by selling securities at times that it might not otherwise be desirable to do so or borrowing the necessary cash, thereby
incurring interest expenses.
In certain situations, the fund may, for a taxable year, defer all or a portion of its net
capital loss realized after October and its late-year ordinary loss (defined as the excess of post-October foreign currency and PFIC losses and other post-December ordinary losses over post-October foreign currency and PFIC gains and other
post-December ordinary income) until the next taxable year in computing its investment company taxable income and net capital gain, which will defer the recognition of such realized losses. Such deferrals and other rules regarding gains and losses
realized after October (or December) may affect the tax character of shareholder distributions.
In general, gain or loss on a
short sale is recognized when the fund closes the sale by delivering the borrowed property to the lender, not when the borrowed property is sold. Gain or loss from a short sale is generally considered as capital gain or loss to the extent that the
property used to close the short sale constitutes a capital asset in the funds hands. Except with respect to certain situations where the property used by the fund to close a short sale has a long-term holding period on the date of the short
sale, special rules would generally treat the gains on short sales as short-term capital gains. These rules may also terminate the running of the holding period of substantially identical property held by the fund. Moreover, a loss on a
short sale will be treated as a long-term capital loss if, on the date of the short sale, substantially identical property has been held by the fund for more than one year. In general, the fund will not be permitted to deduct payments
made to reimburse the lender of securities for dividends paid on borrowed stock if the short sale is closed on or before the 45th day after the short sale is entered into.
Foreign Investments
. Dividends or other income (including, in some cases, capital gains) received by the fund from investments in foreign securities may be subject to withholding and other taxes
imposed by foreign countries. Tax conventions between certain countries and the United States may reduce or eliminate such taxes in some cases. The fund will not be eligible to elect to treat any foreign taxes it pays as paid by its shareholders,
who therefore will not be entitled to credits for such taxes on their own tax returns. Foreign taxes paid by the fund will reduce the return from the funds investments.
Under Section 988 of the Code, gains or losses attributable to fluctuations in exchange rates between the time the fund accrues income or receivables or expenses or other liabilities denominated in a
foreign currency and the time the fund actually collects such income or pays such liabilities are generally treated as ordinary income or ordinary loss. In general, gains (and losses) realized on debt instruments will be treated as Section 988
gain (or loss) to the extent attributable to changes in exchange rates between the U.S. dollar and the currencies in which the instruments are denominated. Similarly, gains or losses on foreign currency, foreign currency forward contracts, certain
foreign currency options or futures contracts and the disposition of debt securities denominated in foreign currency, to the extent attributable to fluctuations in exchange rates between the acquisition and disposition dates, are also treated as
ordinary income or loss unless the fund were to elect otherwise.
Passive Foreign Investment Companies
. If the fund
purchases shares in certain foreign investment entities, called passive foreign investment companies (PFICs), it may be subject to U.S. federal income tax on a portion of any excess distribution or gain from the
disposition of such shares even if such income is distributed as a taxable dividend by the fund to its shareholders. Additional charges in the nature of interest may be imposed on the fund in respect of deferred taxes arising from such distributions
or gains.
If the fund were to invest in a PFIC and elect to treat the PFIC as a qualified electing fund under the
Code, in lieu of the foregoing requirements, the fund might be required to include in income each year a portion of the ordinary earnings and net capital gains of the qualified electing fund, even if not distributed to the fund, and such amounts
would be subject to the 90% and excise tax distribution requirements described above. In order to make this election, the fund would be required to obtain certain annual information from the PFICs in which it invests, which may be difficult or
impossible to obtain.
72
Alternatively, the fund may make a mark-to-market election that will result in the fund
being treated as if it had sold and repurchased its PFIC stock at the end of each year. In such case, the fund would report any such gains as ordinary income and would deduct any such losses as ordinary losses to the extent of previously recognized
gains. The election must be made separately for each PFIC owned by the fund and, once made, would be effective for all subsequent taxable years, unless revoked with the consent of the Internal Revenue Service (the IRS). By making the
election, the fund could potentially ameliorate the adverse tax consequences with respect to its ownership of shares in a PFIC, but in any particular year may be required to recognize income in excess of the distributions it receives from PFICs and
its proceeds from dispositions of PFIC stock. The fund may have to distribute this phantom income and gain to satisfy the 90% distribution requirement and to avoid imposition of the 4% excise tax.
The fund will make the appropriate tax elections, if possible, and take any additional steps that are necessary to mitigate the effect of
these rules.
Beginning in 2014, a withholding tax of 30% will apply to payments of fund dividends and, beginning in 2015,
gross proceeds of fund redemptions paid to shareholders that are non-U.S. entities unless such shareholders comply with certain reporting requirements to the IRS (for non-U.S. investment funds and financial institutions) or the fund (other non-U.S.
entities) as to identifying information (including name, address and taxpayer identification number) of their direct and indirect U.S. owners.
Taxation of U.S. Shareholders
Dividends and Distributions.
Dividends and other distributions by the fund are generally treated under the Code as received by the shareholders at the time the dividend or distribution is made.
However, any dividend declared by the fund in October, November or December of any calendar year and payable to shareholders of record on a specified date in such a month shall be deemed to have been received by each shareholder on December 31
of such calendar year and to have been paid by the fund not later than such December 31, provided such dividend is actually paid by the fund during January of the following calendar year. The fund intends to distribute annually to its
shareholders substantially all of its investment company taxable income, and any net realized long-term capital gains in excess of net realized short-term capital losses (including any capital loss carryovers). However, if the fund retains for
investment an amount equal to all or a portion of its net long-term capital gains in excess of its net short-term capital losses (including any capital loss carryovers), it will be subject to a corporate tax (currently at a maximum rate of 35%) on
the amount retained. In that event, the fund will designate such retained amounts as undistributed capital gains in a notice to its shareholders who (a) will be required to include in income for U.S. federal income tax purposes, as long-term
capital gains, their proportionate shares of the undistributed amount, (b) will be entitled to credit their proportionate shares of the 35% tax paid by the fund on the undistributed amount against their U.S. federal income tax liabilities, if
any, and to claim refunds to the extent their credits exceed their liabilities, if any, and (c) will be entitled to increase their tax basis, for U.S. federal income tax purposes, in their shares by an amount equal to 65% of the amount of
undistributed capital gains included in the shareholders income. Organizations or persons not subject to federal income tax on such capital gains will be entitled to a refund of their pro rata share of such taxes paid by the fund upon filing
appropriate returns or claims for refund with the IRS.
Dividends of net investment income and distributions of net realized
short-term capital gains are taxable to a U.S. shareholder as ordinary income, whether paid in cash or in shares. Distributions of net realized long-term capital gains, if any, that the fund reports as capital gains dividends are taxable as
long-term capital gains, whether paid in cash or in shares and regardless of how long a shareholder has held shares of the fund. Such dividends will not be eligible for the dividends received deduction. Dividends and distributions paid by the fund
attributable to dividends on stock of U.S. corporations received by the fund, with respect to which the fund meets certain holding period requirements, will be eligible for the deduction for dividends received by corporations. Special rules apply,
however, to regular dividends paid to individuals. Such a dividend, with respect to taxable years beginning on or before December 31, 2012, may be subject to tax at the rates generally applicable to
73
long-term capital gains for individuals (currently at a maximum rate of 15%), provided that the individual receiving the dividend satisfies certain holding period and other requirements.
Dividends subject to these special rules are not actually treated as capital gains, however, and thus are not included in the computation of an individuals net capital gain and generally cannot be used to offset capital losses. The long-term
capital gains rates will apply to: (i) 100% of the regular dividends paid by the fund to an individual in a particular taxable year if 95% or more of the funds gross income (ignoring gains attributable to the sale of stocks and securities
except to the extent net short-term capital gain from such sales exceeds net long-term capital loss from such sales) in that taxable year is attributable to qualified dividend income received by the fund; or (ii) the portion of the regular
dividends paid by the fund to an individual in a particular taxable year that is attributable to qualified dividend income received by the fund in that taxable year if such qualified dividend income accounts for less than 95% of the funds
gross income (ignoring gains attributable to the sale of stocks and securities except to the extent net short-term capital gain from such sales exceeds net long-term capital loss from such sales) for that taxable year. For this purpose,
qualified dividend income generally means income from dividends received by the fund from U.S. corporations and qualified foreign corporations, provided that the fund satisfies certain holding period requirements in respect of the stock
of such corporations and has not hedged its position in the stock in certain ways. Also, dividends received by the fund from a REIT or another regulated investment company generally are qualified dividend income only to the extent the dividend
distributions are made out of qualified dividend income received by such REIT or other regulated investment company. In the case of securities lending transactions, payments in lieu of dividends are not qualified dividend income. If a shareholder
elects to treat fund dividends as investment income for purposes of the limitation on the deductibility of investment interest, such dividends would not be qualified dividend income.
For taxable years beginning on or after January 1, 2013, the long-term capital gain rate is scheduled to return to 20%.
We will send you information after the end of each year setting forth the amount of dividends paid by us that are eligible for the
reduced rates.
If an individual receives a regular dividend qualifying for the long-term capital gains rates and such
dividend constitutes an extraordinary dividend, and the individual subsequently recognizes a loss on the sale or exchange of stock in respect of which the extraordinary dividend was paid, then the loss will be long-term capital loss to
the extent of such extraordinary dividend. An extraordinary dividend on common stock for this purpose is generally a dividend (i) in an amount greater than or equal to 10% of the taxpayers tax basis (or trading value) in a
share of stock, aggregating dividends with ex-dividend dates within an 85-day period or (ii) in an amount greater than 20% of the taxpayers tax basis (or trading value) in a share of stock, aggregating dividends with ex-dividend dates
within a 365-day period. Distributions in excess of the funds current and accumulated earnings and profits will, as to each shareholder, be treated as a tax-free return of capital to the extent of a shareholders basis in his shares of
the fund, and as a capital gain thereafter (if the shareholder holds his shares of the fund as capital assets). Shareholders receiving dividends or distributions in the form of additional shares should be treated for U.S. federal income tax purposes
as receiving a distribution in an amount equal to the amount of money that the shareholders receiving cash dividends or distributions will receive, and should have a cost basis in the shares received equal to such amount.
Investors considering buying shares just prior to the record date for a taxable dividend or capital gain distribution should be aware
that, although the price of shares just purchased at that time may reflect the amount of the forthcoming distribution, such dividend or distribution may nevertheless be taxable to them. If the fund is the holder of record of any stock on the record
date for any dividends payable with respect to such stock, such dividends are included in the funds gross income not as of the date received but as of the later of (a) the date such stock became ex-dividend with respect to such dividends
(
i.e.
, the date on which a buyer of the stock would not be entitled to receive the declared, but unpaid, dividends) or (b) the date the fund acquired such stock. Accordingly, in order to satisfy its income distribution requirements, the
fund may be required to pay dividends based on anticipated earnings, and shareholders may receive dividends in an earlier year than would otherwise be the case.
74
Under current law, the fund serves to block unrelated business taxable income
(UBTI) from being realized by its tax-exempt shareholders. Notwithstanding the foregoing, a tax-exempt shareholder could realize UBTI by virtue of its investment in the fund if shares in the fund constitute debt-financed property in the
hands of the tax-exempt shareholder within the meaning of Code Section 514(b). Certain types of income received by the fund from REITs, real estate mortgage investment conduits, taxable mortgage pools or other investments may cause the fund to
designate some or all of its distributions as excess inclusion income. To fund shareholders such excess inclusion income may (1) constitute taxable income, as UBTI for those shareholders who would otherwise be tax-exempt such as
individual retirement accounts, 401(k) accounts, Keogh plans, pension plans and certain charitable entities; (2) not be offset by otherwise allowable deductions for tax purposes; (3) not be eligible for reduced U.S. withholding for
non-U.S. shareholders even from tax treaty countries; and (4) cause the fund to be subject to tax if certain disqualified organizations as defined by the Code are fund shareholders.
If a charitable remainder annuity trust or charitable remainder unitrust (each as defined in Code Section 664) has UBTI for a tax
year, a 100% excise tax on the UBTI is imposed on the trust.
Sales of Shares.
Upon the sale or exchange of his shares,
a shareholder will realize a taxable gain or loss equal to the difference between the amount realized and his or her basis in the shares. A redemption of shares by the fund will be treated as a sale for this purpose. Such gain or loss will be
treated as capital gain or loss if the shares are capital assets in the shareholders hands, and will be long-term capital gain or loss if the shares are held for more than one year and short-term capital gain or loss if the shares are held for
one year or less. Any loss realized on a sale or exchange will be disallowed to the extent the shares disposed of are replaced, including replacement through the reinvesting of dividends and capital gains distributions in the fund, within a 61-day
period beginning 30 days before and ending 30 days after the disposition of the shares. In such a case, the basis of the shares acquired will be increased to reflect the disallowed loss. Any loss realized by a shareholder on the sale of a fund share
held by the shareholder for six months or less will be treated for U.S. federal income tax purposes as a long-term capital loss to the extent of any distributions or deemed distributions of long-term capital gains received by the shareholder with
respect to such share during such six month period. If a shareholder incurs a sales charge in acquiring shares of the fund, disposes of those shares within 90 days and then by January 31 of the calendar year following the year of disposition
acquires shares in a mutual fund for which the otherwise applicable sales charge is reduced by reason of a reinvestment right (
e.g.,
an exchange privilege), the original sales charge will not be taken into account in computing gain or loss on
the original shares to the extent the subsequent sales charge is reduced. Instead, the disregarded portion of the original sales charge will be added to the tax basis of the newly acquired shares. Furthermore, the same rule also applies to a
disposition of the newly acquired shares made within 90 days of the second acquisition. This provision prevents a shareholder from immediately deducting the sales charge by shifting his or her investment in a family of mutual funds.
The fund, or, if you hold your shares through a Service Agent, your Service Agent will report to the IRS the amount of proceeds that a
shareholder receives from a redemption or exchange of fund shares. For redemptions or exchanges of shares acquired on or after January 1, 2012, the fund will also report the shareholders basis in those shares and the character of any gain
or loss that the shareholder realizes on the redemption or exchange (
i.e.,
short-term or long-term), and certain related tax information. If a shareholder has a different basis for different shares of the fund in the same account
(
e.g.
, if a shareholder purchased fund shares held in the same account when the shares were at different prices), the fund will by default report the basis of the shares redeemed or exchanged using the average basis method, under which the
basis per share is the average of the bases of all the shareholders fund shares in the account. (For these purposes, shares acquired prior to January 1, 2012 and shares acquired on or after January 1, 2012 will be treated as held in
separate accounts.)
A shareholder may instruct the fund to use a method other than average basis for an account. If
redemptions, including in connection with payment of an account fee, or exchanges have occurred in an account to which the average basis method applied, the basis of the fund shares remaining in the account will continue to reflect the average basis
notwithstanding the shareholders subsequent election of a different method. For further assistance, shareholders who hold their shares directly with the fund may call the fund at 1-877-721-1926 Monday through
75
Friday between 8:00 a.m. and 5:30 p.m. (Eastern time). Shareholders who hold shares through a Service Agent should contact the Service Agent for further assistance or for information regarding
the Service Agents default method for calculating basis and procedures for electing to use an alternative method. Shareholders should consult their tax advisers concerning the tax consequences of applying the average basis method or electing
another method of basis calculation, and should consider electing such other method prior to making redemptions or exchanges in their account.
Backup Withholding.
The fund may be required to withhold, for U.S. federal income tax purposes, a portion of the dividends, distributions and redemption proceeds payable to shareholders who fail to
provide the fund with their correct taxpayer identification number or to make required certifications, or who have been notified by the IRS that they are subject to backup withholding. Certain shareholders are exempt from backup withholding. Backup
withholding is not an additional tax and any amount withheld may be credited against a shareholders U.S. federal income tax liability.
Notices.
Shareholders will be notified annually by the fund as to the U.S. federal income tax status of the dividends, distributions and deemed distributions attributable to undistributed capital
gains (discussed above in Taxes-Taxation of U.S. Shareholders-Dividends and Distributions) made by the fund to its shareholders. Furthermore, shareholders will also receive, if appropriate, various written notices after the close of the
funds taxable year regarding the U.S. federal income tax status of certain dividends, distributions and deemed distributions that were paid (or that are treated as having been paid) by the fund to its shareholders during the preceding taxable
year.
If the fund is held through a qualified retirement plan entitled to tax exempt treatment for federal income tax
purposes, distributions will generally not be taxable currently. Special tax rules apply to such retirement plans. You should consult your tax adviser regarding the tax treatment of distributions (which may include amounts attributable to fund
distributions) which may be taxable when distributed from the retirement plan.
Other Taxes
Dividends, distributions and redemption proceeds may also be subject to additional state, local and foreign taxes depending on each
shareholders particular situation.
If a shareholder recognizes a loss with respect to the funds shares of $2
million or more for an individual shareholder or $10 million or more for a corporate shareholder, the shareholder must file with the IRS a disclosure statement on Form 8886. Direct shareholders of portfolio securities are in many cases excepted from
this reporting requirement, but under current guidance, shareholders of a regulated investment company are not excepted. The fact that a loss is reportable under these regulations does not affect the legal determination of whether the
taxpayers treatment of the loss is proper. Shareholders should consult their tax advisers to determine the applicability of these regulations in light of their individual circumstances.
Taxation of Non-U.S. Shareholders
Dividends paid by the fund to non-U.S.
shareholders are generally subject to withholding tax at a 30% rate or a reduced rate specified by an applicable income tax treaty to the extent derived from investment income and short-term capital gains. In order to obtain a reduced rate of
withholding, a non-U.S. shareholder will be required to provide an IRS Form W-8BEN certifying its entitlement to benefits under a treaty. The withholding tax does not apply to regular dividends paid to a non-U.S. shareholder who provides a Form
W-8ECI, certifying that the dividends are effectively connected with the non-U.S. shareholders conduct of a trade or business within the United States. Instead, the effectively connected dividends will be subject to regular U.S. income tax as
if the non-U.S. shareholder were a U.S. shareholder. A non-U.S. corporation receiving effectively connected dividends may also be subject to additional branch profits tax imposed at a rate of 30% (or lower treaty rate). A non-U.S.
shareholder who fails to provide an IRS Form W-8BEN or other applicable form may be subject to backup withholding at the appropriate rate.
76
In general, U.S. federal withholding tax will not apply to any gain or income realized by a
non-U.S. shareholder in respect of any distributions of net long-term capital gains over net short-term capital losses, exempt-interest dividends, or upon the sale or other disposition of shares of the fund.
For taxable years beginning before January 1, 2012, properly reported dividends are generally exempt from U.S. federal withholding
tax where they (i) are paid in respect of the funds qualified net interest income (generally, the funds U.S. source interest income, other than certain contingent interest and interest from obligations of a corporation
or partnership in which the fund is at least a 10% shareholder, reduced by expenses that are allocable to such income) or (ii) are paid in respect of the funds qualified short-term capital gains (generally, the excess of the
funds net short-term capital gain over the funds long-term capital loss for such taxable year). However, depending on its circumstances, the fund may report all, some or none of its potentially eligible dividends as such qualified net
interest income or as qualified short-term capital gains and/or treat such dividends, in whole or in part, as ineligible for this exemption from withholding. In order to qualify for this exemption from withholding, a non-U.S. shareholder will need
to comply with applicable certification requirements relating to its non-U.S. status (including, in general, furnishing an IRS Form W-8BEN or substitute Form). In the case of shares held through an intermediary, the intermediary may withhold even if
the fund reports the payment as qualified net interest income or qualified short-term capital gain. Non-U.S. shareholders should contact their intermediaries with respect to the application of these rules to their accounts.
For taxable years beginning before January 1, 2012, distributions that the fund reports as short-term capital gain
dividends or long-term capital gain dividends will not be treated as such to a recipient non-U.S. shareholder if the distribution is attributable to gain received from the sale or exchange of U.S. real property or an interest in a
U.S. real property holding corporation and the funds direct or indirect interests in U.S. real property exceeded certain levels. Instead, if the non-U.S. shareholder has not owned more than 5% of the outstanding shares of the fund at any time
during the one year period ending on the date of distribution, such distributions will be subject to 30% withholding by the fund and will be treated as ordinary dividends to the non-U.S. shareholder; if the non-U.S. shareholder owned more than 5% of
the outstanding shares of the fund at any time during the one year period ending on the date of the distribution, such distribution will be treated as real property gain subject to 35% withholding tax and could subject the non-U.S. shareholder to
U.S. filing requirements. Additionally, if the funds direct or indirect interests in U.S. real property were to exceed certain levels, a non-U.S. shareholder realizing gains upon redemption from the fund on or before December 31, 2011
could be subject to the 35% withholding tax and U.S. filing requirements unless more than 50% of the funds shares were owned by U.S. persons at such time or unless the non-U.S. person had not held more than 5% of the funds outstanding
shares throughout either such persons holding period for the redeemed shares or, if shorter, the previous five years.
In addition, the same rules apply with respect to distributions to a non-U.S. shareholder from the fund and redemptions of a non-U.S.
shareholders interest in the fund attributable to a REITs distribution to the fund of gain from the sale or exchange of U.S. real property or an interest in a U.S. real property holding corporation, if the funds direct or indirect
interests in U.S. real property were to exceed certain levels. The rule with respect to distributions and redemptions attributable to a REITs distribution to the fund will not expire for taxable years beginning on or after January 1,
2012.
The rules laid out in the previous two paragraphs, other than the withholding rules, will apply notwithstanding the
funds participation in a wash sale transaction or its payment of a substitute dividend.
Under legislation known as
FATCA (the Foreign Account Tax Compliance Act), the fund will be required to withhold 30% of certain ordinary dividends it pays after December 31, 2013, and 30% of the gross proceeds of share redemptions and certain capital gain
dividends it pays after December 31, 2016, to shareholders that fail to meet prescribed information reporting or certification requirements. In general, no such withholding will be required with respect to a U.S. person or non-U.S. individual
that timely provides the certifications required by the fund or its agent on a valid IRS Form W-9 or W-8, respectively. Shareholders potentially subject to
77
withholding include foreign financial institutions (FFIs), such as non-U.S. investment funds, and non-financial foreign entities (NFFEs). To avoid withholding under FATCA,
an FFI generally must enter into an information sharing agreement with the Internal Revenue Service (IRS) in which it agrees to report certain identifying information (including name, address, and taxpayer identification number) with
respect to its U.S. account holders (which, in the case of an entity shareholder, may include its direct and indirect U.S. owners), and an NFFE generally must identify and provide other required information to the fund or other withholding agent
regarding its U.S. owners, if any. Such non-U.S. shareholders also may fall into certain exempt, excepted or deemed compliant categories as established by regulations and other guidance. A non-U.S. shareholder resident or doing business in a country
that has entered into an intergovernmental agreement with the U.S. to implement FATCA will be exempt from FATCA withholding provided that the shareholder and the applicable foreign government comply with the terms of such agreement.
The IRS has indicated that an FFI that is subject to the information sharing requirement will need to enter into such an agreement with
the IRS by June 30, 2013, to ensure that it will be identified as FATCA-compliant in sufficient time to allow the fund to refrain from withholding beginning on January 1, 2014. A non-U.S. entity that invests in the fund will need to
provide the fund with documentation properly certifying the entitys status under FATCA in order to avoid FATCA withholding.
Non-U.S. investors should consult their own tax advisers regarding the impact of these requirements on their investment in the fund.
The tax consequences to a non-U.S. shareholder entitled to claim the benefits of an applicable tax treaty may be different from those
described here. Foreign shareholders should consult their own tax advisers with respect to the particular tax consequences to them of an investment in the fund, including the applicability of non-U.S. taxes.
Shares of the fund held by a non-U.S. shareholder at death will be considered situated in the United States and subject to the U.S.
estate tax.
The foregoing is only a summary of certain material U.S. federal income tax consequences affecting the fund
and its shareholders. Current and prospective shareholders are advised to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the fund.
FINANCIAL STATEMENTS
As the fund commenced operations on [ ], 2013, no financial information is available as of the date of this SAI.
78
APPENDIX A
DESCRIPTION OF RATINGS
The ratings of Moodys, Standard & Poors and Fitch Ratings represent their opinions as to the quality of various debt obligations. It should be emphasized, however, that ratings are
not absolute standards of quality. Consequently, debt obligations with the same maturity, coupon and rating may have different yields while debt obligations of the same maturity and coupon with different ratings may have the same yield. As described
by the rating agencies, ratings are generally given to securities at the time of issuances. While the rating agencies may from time to time revise such ratings, they undertake no obligation to do so.
Description of Moodys Long-Term Obligation Ratings:
Moodys long-term obligation ratings are opinions of the relative credit risk of fixed income obligations with an original maturity of one year or more. They address the possibility that a financial
obligation will not be honored as promised. Such ratings reflect both the likelihood of default and any financial loss suffered in the event of default.
Aaa
Obligations rated Aaa are judged to be of the highest quality, with minimal credit risk.
Aa
Obligations rated Aa are judged to be of high quality and are subject to very low credit risk.
A
Obligations rated A are considered upper-medium grade and are subject to low credit risk.
Baa
Obligations rated Baa are subject to moderate credit risk. They are considered medium-grade and as such may possess certain speculative characteristics.
Ba
Obligations rated Ba are judged to have speculative elements and are subject to substantial credit risk.
B
Obligations rated B are considered speculative and are subject to high credit risk.
Caa
Obligations rated Caa are judged to be of poor standing and are subject to very high credit risk.
Ca
Obligations rated Ca are highly speculative and are likely in, or very near, default, with some prospect of recovery of
principal and interest.
C
Obligations rated C are the lowest rated class of bonds and are typically in default,
with little prospect for recovery of principal or interest.
Note: Moodys appends numerical modifiers
1, 2 and 3 to each generic rating classification from Aa through Caa. The modifier 1 indicates that the obligation ranks in the higher end of its generic rating category; the
modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generic rating category.
Description of Moodys US Municipal and Tax Exempt Ratings:
Municipal
Ratings are opinions of the investment quality of issuers and issues in the US municipal and tax-exempt markets. As such, these ratings incorporate Moodys assessment of the default probability and loss severity of these issuers and issues. The
default and loss content for Moodys municipal long-term rating scale differs from Moodys general long-term rating scale.
A-1
Municipal Ratings are based upon the analysis of four primary factors relating to municipal
finance: economy, debt, finances, and administration/management strategies. Each of the factors is evaluated individually and for its effect on the other factors in the context of the municipalitys ability to repay its debt.
Municipal Long-Term Rating Definitions:
Aaa
Issuers or issues rated Aaa demonstrate the strongest creditworthiness relative to other US municipal or tax-exempt issuers or issues.
Aa
Issuers or issues rated Aa demonstrate very strong creditworthiness relative to other US municipal or tax-exempt issuers
or issues.
A
Issuers or issues rated A present above-average creditworthiness relative to other US municipal or
tax-exempt issuers or issues.
Baa
Issuers or issues rated Baa represent average creditworthiness relative to
other US municipal or tax-exempt issuers or issues.
Ba
Issuers or issues rated Ba demonstrate below-average
creditworthiness relative to other US municipal or tax-exempt issuers or issues.
B
Issuers or issues rated B
demonstrate weak creditworthiness relative to other US municipal or tax-exempt issuers or issues.
Caa
Issuers or
issues rated Caa demonstrate very weak creditworthiness relative to other US municipal or tax-exempt issuers or issues.
Ca
Issuers or issues rated Ca demonstrate extremely weak creditworthiness relative to other US municipal or tax-exempt
issuers or issues.
C
Issuers or issues rated C demonstrate the weakest creditworthiness relative to other US
municipal or tax-exempt issuers or issues.
Note:
Moodys appends numerical modifiers 1,
2 and 3 to each generic rating classification from Aa through Caa. The modifier 1 indicates that the obligation ranks in the higher end of its generic rating category; the modifier
2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generic rating category.
Description of Moodys US Municipal Short-Term Debt And Demand Obligation Ratings:
There are three rating categories for short-term municipal obligations that are considered investment grade. These ratings are designated as Municipal Investment Grade (MIG) and are divided
into three levels-MIG 1 through MIG 3. In addition, those short-term obligations that are of speculative quality are designated SG, or speculative grade. MIG ratings expire at the maturity of the obligation.
MIG 1
This designation denotes superior credit quality. Excellent protection is afforded by established cash
flows, highly reliable liquidity support, or demonstrated broad-based access to the market for refinancing.
MIG
2
This designation denotes strong credit quality. Margins of protection are ample, although not as large as in the preceding group.
MIG 3
This designation denotes acceptable credit quality. Liquidity and cash-flow protection may be narrow, and market access for refinancing is likely to be less well-established.
A-2
SG
This designation denotes speculative-grade credit quality. Debt instruments
in this category may lack sufficient margins of protection.
Description of Moodys Demand Obligation Ratings:
In the case of variable rate demand obligations (VRDOs), a two-component rating is assigned; a long or short-term debt rating
and a demand obligation rating. The first element represents Moodys evaluation of the degree of risk associated with scheduled principal and interest payments. The second element represents Moodys evaluation of the degree of risk
associated with the ability to receive purchase price upon demand (demand feature), using a variation of the MIG rating scale, the Variable Municipal Investment Grade or VMIG rating. When either the long-or short-term aspect of a VRDO is
not rated, that piece is designated NR,
e.g.
, Aaa/NR or NR/VMIG 1. VMIG rating expirations are a function of each issues specific structural or credit features.
VMIG 1
This designation denotes superior credit quality. Excellent protection is afforded by the superior short-term credit strength of the liquidity provider and structural and legal
protections that ensure the timely payment of purchase price upon demand.
VMIG 2
This designation denotes strong
credit quality. Good protection is afforded by the strong short-term credit strength of the liquidity provider and structural and legal protections that ensure the timely payment of purchase price upon demand.
VMIG 3
This designation denotes acceptable credit quality. Adequate protection is afforded by the satisfactory short-term
credit strength of the liquidity provider and structural and legal protections that ensure the timely payment of purchase price upon demand.
SG
This designation denotes speculative-grade credit quality. Demand features rated in this category may be supported by a liquidity provider that does not have an investment grade short-term
rating or may lack the structural and/or legal protections necessary to ensure the timely payment of purchase price upon demand.
Description of Moodys Short-Term Prime Ratings:
Moodys short-term ratings are opinions of the ability of issuers to honor short-term financial obligations. Ratings may be assigned to issuers, short-term programs or to individual short-term debt
instruments. Such obligations generally have an original maturity not exceeding thirteen months, unless explicitly noted.
P-1
Issuers (or supporting institutions) rated Prime-1 have a superior ability to repay short-term debt obligations.
P-2
Issuers (or supporting institutions) rated Prime-2 have a strong ability to repay short-term debt
obligations.
P-3
Issuers (or supporting institutions) rated Prime-3 have an acceptable ability to repay
short-term obligations.
NP
Issuers (or supporting institutions) rated Not Prime do not fall within any of the
Prime rating categories.
Note:
Canadian issuers rated P-1 or P-2 have their short-term ratings enhanced by the
senior-most long-term rating of the issuer, its guarantor or support-provider.
A-3
Description of Standard & Poors Long-Term Issue Credit Ratings:
Issue credit ratings are based, in varying degrees, on the following considerations: (1) likelihood of paymentcapacity and
willingness of the obligor to meet its financial commitment on an obligation in accordance with the terms of the obligation; (2) nature of and provisions of the obligation; and (3) protection afforded by, and relative position of, the
obligation in the event of bankruptcy, reorganization, or other arrangement under the laws of bankruptcy and other laws affecting creditors rights.
The issue rating definitions are expressed in terms of default risk. As such, they pertain to senior obligations of an entity. Junior obligations are typically rated lower than senior obligations, to
reflect the lower priority in bankruptcy, as noted above. (Such differentiation applies when an entity has both senior and subordinated obligations, secured and unsecured obligations, or operating company and holding company obligations.)
Accordingly, in the case of junior debt, the rating may not conform exactly with the category definition.
AAA
An
obligation rated AAA has the highest rating assigned by Standard & Poors. The obligors capacity to meet its financial commitments on the obligation is extremely strong.
AA
An obligation rated AA differs from the highest-rated obligations only to a small degree. The obligors
capacity to meet its financial obligations is very strong.
A
An obligation rated A is somewhat more
susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher rated categories. However, the obligors capacity to meet its financial commitment on the obligation is still strong.
BBB
An obligation rated BBB exhibits adequate protection parameters. However, adverse economic conditions or
changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.
BB, B, CCC, CC, and C
Obligations rated BB, B, CCC, CC, and C are regarded as having significant speculative characteristics.
BB indicates the least degree of speculation and C the highest. While such obligations will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to adverse
conditions.
BB
An obligation rated BB is less vulnerable to nonpayment than other speculative issues.
However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions, which could lead to the obligors inadequate capacity to meet its financial commitment on the obligation.
B
An obligation rated B is more vulnerable to nonpayment than obligations rated BB, but the obligor
currently has the capacity to meet its financial commitment on the obligation. Adverse business, financial, or economic conditions will likely impair the obligors capacity or willingness to meet its financial commitment on the obligation.
CCC
An obligation rated CCC is currently vulnerable to nonpayment and is dependent upon favorable
business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its
financial commitment on the obligation.
CC
An obligation rated CC is currently highly vulnerable to
nonpayment.
C
A subordinated debt or preferred stock obligation rated C is currently highly
vulnerable to nonpayment. The C rating may be used to cover a situation where a bankruptcy petition has been filed or similar action taken, but payments on this obligation are being continued. A C also will be assigned to a
preferred stock issue in arrears on dividends or sinking fund payments, but that is currently paying.
A-4
D
An obligation rated D is in payment default. The D
rating category is used when payments on an obligation are not made on the date due even if the applicable grace period has not expired, unless Standard & Poors believes that such payments will be made during such grace period. The
D rating also will be used upon the filing of a bankruptcy petition or the taking of a similar action if payments on an obligation are jeopardized.
Plus (+) or Minus (): The ratings from AA to CCC may be modified by the addition of a plus (+) or minus () sign to show relative standing within the
major rating categories.
N.R.: This indicates that no rating has been requested, that there is insufficient information on
which to base a rating, or that Standard & Poors does not rate a particular obligation as a matter of policy.
Active Qualifiers (Currently applied and/or outstanding)
i: This subscript is used for issues in which the credit factors, terms, or both, that determine the likelihood of receipt of payment of interest are different from the credit factors, terms or both
that determine the likelihood of receipt of principal on the obligation. The i subscript indicates that the rating addresses the interest portion of the obligation only. The i subscript will always be used in conjunction with
the p subscript, which addresses likelihood of receipt of principal. For example, a rated obligation could be assigned ratings of AAAp NRi indicating that the principal portion is rated AAA and the interest
portion of the obligation is not rated.
L: Ratings qualified with L apply only to amounts invested up to
federal deposit insurance limits.
p: This subscript is used for issues in which the credit factors, the terms, or both,
that determine the likelihood of receipt of payment of principal are different from the credit factors, terms or both that determine the likelihood of receipt of interest on the obligation. The p subscript indicates that the rating
addresses the principal portion of the obligation only. The p subscript will always be used in conjunction with the i subscript, which addresses likelihood of receipt of interest. For example, a rated obligation could be
assigned ratings of AAAp NRi indicating that the principal portion is rated AAA and the interest portion of the obligation is not rated.
pi: Ratings with a pi subscript are based on an analysis of an issuers published financial information, as well as additional information in the public domain. They do not, however,
reflect in-depth meetings with an issuers management and are therefore based on less comprehensive information than ratings without a pi subscript. Ratings with a pi subscript are reviewed annually based on a new
years financial statements, but may be reviewed on an interim basis if a major event occurs that may affect the issuers credit quality.
pr: The letters pr indicate that the rating is provisional. A provisional rating assumes the successful completion of the project financed by the debt being rated and indicates that
payment of debt service requirements is largely or entirely dependent upon the successful, timely completion of the project. This rating, however, while addressing credit quality subsequent to completion of the project, makes no comment on the
likelihood of or the risk of default upon failure of such completion. The investor should exercise his own judgment with respect to such likelihood and risk.
preliminary: Preliminary ratings are assigned to issues, including financial programs, in the following circumstances. Preliminary ratings may be assigned to obligations, most commonly structured and
project finance issues, pending receipt of final documentation and legal opinions. Assignment of a final rating is conditional on the receipt and approval by Standard & Poors of appropriate documentation. Changes in the information
provided to Standard & Poors could result in the assignment of a different rating. In addition, Standard & Poors reserves the right not to issue a final rating. Preliminary ratings are assigned to Rule 415 Shelf
Registrations. As specific issues, with defined terms, are offered from the master registration, a final rating may be assigned to them in accordance with Standard & Poors policies. The final rating may differ from the preliminary
rating.
A-5
t: This symbol indicates termination structures that are designed to honor their
contracts to full maturity or, should certain events occur, to terminate and cash settle all their contracts before their final maturity date.
Local Currency and Foreign Currency Risks: Country risk considerations are a standard part of Standard & Poors analysis for credit ratings on any issuer or issue. Currency of repayment
is a key factor in this analysis. An obligors capacity to repay foreign currency obligations may be lower than its capacity to repay obligations in its local currency due to the sovereign governments own relatively lower capacity to
repay external versus domestic debt. These sovereign risk considerations are incorporated in the debt ratings assigned to specific issues. Foreign currency issuer ratings are also distinguished from local currency issuer ratings to identify those
instances where sovereign risks make them different for the same issuer.
Description of Standard & Poors Ratings of Notes:
A Standard & Poors U.S. municipal note rating reflects the liquidity factors and market access risks
unique to notes. Notes due in three years or less will likely receive a note rating. Notes maturing beyond three years will most likely receive a long-term debt rating. The following criteria will be used in making that assessment:
|
|
Amortization schedulethe larger the final maturity relative to other maturities, the more likely it will be treated as a note; and
|
|
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Source of paymentthe more dependent the issue is on the market for its refinancing, the more likely it will be treated as a note.
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Note rating symbols are as follows:
SP-1
Strong capacity to pay principal and interest. An issue determined to possess a very strong capacity to pay debt service is given a plus (+) designation.
SP-2
Satisfactory capacity to pay principal and interest, with some vulnerability to adverse financial and economic changes
over the term of the notes.
SP-3
Speculative capacity to pay principal and interest.
Description of Standard & Poors Short-Term Issue Credit Ratings:
A-1
Short-term obligation rated A-1 is rated in the highest category by Standard & Poors. The
obligors capacity to meet its financial commitment on the obligation is strong. Within this category, certain obligations are designated with a plus sign (+). This indicates that the obligors capacity to meet its financial commitments is
extremely strong.
A-2
Short-term obligation rated A-2 is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations in higher rating categories. However, the obligors capacity to meet its financial commitment on the obligation is satisfactory.
A-3
Short-term obligation rated A-3 exhibits adequate protection parameters. However, adverse economic conditions
or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.
B
A short-term obligation rated B is regarded as having significant speculative characteristics. Ratings of B-1, B-2, and B-3 may be assigned to
indicate finer distinctions within the B category. The obligor currently has the capacity to meet its financial commitment on the obligation; however, it faces major ongoing uncertainties which could lead to the obligors inadequate
capacity to meet its financial commitment on the obligation.
A-6
B-1
A short-term obligation rated B-1 is regarded as having
significant speculative characteristics, but the obligor has a relatively stronger capacity to meet its financial commitments over the short-term compared to other speculative-grade obligors.
B-2
A short-term obligation rated B-2 is regarded as having significant speculative characteristics, and the
obligor has an average speculative-grade capacity to meet its financial commitments over the short-term compared to other speculative-grade obligors.
B-3
A short-term obligation rated B-3 is regarded as having significant speculative characteristics, and the obligor has a relatively weaker capacity to meet its financial
commitments over the short-term compared to other speculative-grade obligors.
C
A short-term obligation rated
C is currently vulnerable to nonpayment and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation.
D
A short-term obligation rated D is in payment default. The D rating category is used when payments
on an obligation are not made on the date due even if the applicable grace period has not expired, unless Standard & Poors believes that such payments will be made during such grace period. The D rating also will be used
upon the filing of a bankruptcy petition or the taking of a similar action if payments on an obligation are jeopardized.
Active Qualifiers (Currently applied and/or outstanding)
i: This subscript is used for issues in which the credit factors, terms, or both, that determine the likelihood of receipt of payment of interest are different from the credit factors, terms or both
that determine the likelihood of receipt of principal on the obligation. The i subscript indicates that the rating addresses the interest portion of the obligation only. The i subscript will always be used in conjunction with
the p subscript, which addresses likelihood of receipt of principal. For example, a rated obligation could be assigned ratings of AAAp NRi indicating that the principal portion is rated AAA and the interest
portion of the obligation is not rated.
L: Ratings qualified with L apply only to amounts invested up to
federal deposit insurance limits.
p: This subscript is used for issues in which the credit factors, the terms, or both,
that determine the likelihood of receipt of payment of principal are different from the credit factors, terms or both that determine the likelihood of receipt of interest on the obligation. The p subscript indicates that the rating
addresses the principal portion of the obligation only. The p subscript will always be used in conjunction with the i subscript, which addresses likelihood of receipt of interest. For example, a rated obligation could be
assigned ratings of AAAp NRi indicating that the principal portion is rated AAA and the interest portion of the obligation is not rated.
pi: Ratings with a pi subscript are based on an analysis of an issuers published financial information, as well as additional information in the public domain. They do not, however,
reflect in-depth meetings with an issuers management and are therefore based on less comprehensive information than ratings without a pi subscript. Ratings with a pi subscript are reviewed annually based on a new
years financial statements, but may be reviewed on an interim basis if a major event occurs that may affect the issuers credit quality.
pr: The letters pr indicate that the rating is provisional. A provisional rating assumes the successful completion of the project financed by the debt being rated and indicates that
payment of debt service requirements is largely or entirely dependent upon the successful, timely completion of the project. This rating, however, while addressing credit quality subsequent to completion of the project, makes no comment on the
likelihood of or the risk of default upon failure of such completion. The investor should exercise his own judgment with respect to such likelihood and risk.
A-7
preliminary: Preliminary ratings are assigned to issues, including financial programs, in
the following circumstances. Preliminary ratings may be assigned to obligations, most commonly structured and project finance issues, pending receipt of final documentation and legal opinions. Assignment of a final rating is conditional on the
receipt and approval by Standard & Poors of appropriate documentation. Changes in the information provided to Standard & Poors could result in the assignment of a different rating. In addition, Standard &
Poors reserves the right not to issue a final rating. Preliminary ratings are assigned to Rule 415 Shelf Registrations. As specific issues, with defined terms, are offered from the master registration, a final rating may be assigned to
them in accordance with Standard & Poors policies. The final rating may differ from the preliminary rating.
t: This symbol indicates termination structures that are designed to honor their contracts to full maturity or, should certain
events occur, to terminate and cash settle all their contracts before their final maturity date. Local Currency and Foreign Currency Risks: Country risk considerations are a standard part of Standard & Poors analysis for credit
ratings on any issuer or issue. Currency of repayment is a key factor in this analysis. An obligors capacity to repay foreign currency obligations may be lower than its capacity to repay obligations in its local currency due to the sovereign
governments own relatively lower capacity to repay external versus domestic debt. These sovereign risk considerations are incorporated in the debt ratings assigned to specific issues. Foreign currency issuer ratings are also distinguished from
local currency issuer ratings to identify those instances where sovereign risks make them different for the same issuer.
Description of
Standard & Poors Ratings of Commercial Paper:
A Standard & Poors commercial paper rating is
a current assessment of the likelihood of timely payment of debt having an original maturity of no more than 365 days. Ratings are graded into several categories, ranging from A for the highest-quality obligations to D
for the lowest. These categories are as follows:
A-1
This designation indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess extremely strong safety characteristics are denoted with a plus sign (+) designation.
A-2
Capacity for timely payment on issues with this designation is satisfactory. However, the relative degree of safety is not as high as for issues designated A-1.
A-3
Issues carrying this designation have an adequate capacity for timely payment. They are, however, more vulnerable to the
adverse effects of changes in circumstances than obligations carrying the higher designations.
B
Issues rated
B are regarded as having only speculative capacity for timely payment.
C
This rating is assigned to
short-term debt obligations with a doubtful capacity for payment.
D
Debt rated D is in payment
default. The D rating category is used when interest payments of principal payments are not made on the date due, even if the applicable grace period has not expired, unless Standard & Poors believes such payments will be
made during such grace period.
Description of Standard & Poors Dual Ratings:
Standard & Poors assigns dual ratings to all debt issues that have a put option or demand feature as part of
their structure.
The first rating addresses the likelihood of repayment of principal and interest as due, and the second
rating addresses only the demand feature. The long-term debt rating symbols are used for bonds to denote the long-term maturity and the commercial paper rating symbols for the put option (for example, AAA/A-1+). With short-term demand
debt, Standard & Poors note rating symbols are used with the commercial paper rating symbols (for example, SP-1+/A-1+).
A-8
Description of Fitch Ratings International Long-Term Credit Ratings:
International Long-Term Credit Ratings (LTCR) may also be referred to as Long-Term Ratings. When assigned to most
issuers, it is used as a benchmark measure of probability of default and is formally described as an Issuer Default Rating (IDR). The major exception is within Public Finance, where IDRs will not be assigned as market convention has always focused
on timeliness and does not draw analytical distinctions between issuers and their underlying obligations. When applied to issues or securities, the LTCR may be higher or lower than the issuer rating (IDR) to reflect relative differences in recovery
expectations. The following rating scale applies to foreign currency and local currency ratings.
Investment Grade
AAA
Highest credit quality. AAA ratings denote the lowest expectation of credit risk. They
are assigned only in case of exceptionally strong capacity for payment of financial commitments. This capacity is highly unlikely to be adversely affected by foreseeable events.
AA
Very high credit quality. AA ratings denote expectations of very low credit risk. They indicate very
strong capacity for payment of financial commitments. This capacity is not significantly vulnerable to foreseeable events.
A
High credit quality. A ratings denote expectations of low credit risk. The capacity for payment of
financial commitments is considered strong. This capacity may, nevertheless, be more vulnerable to changes in circumstances or in economic conditions than is the case for higher ratings.
BBB
Good credit quality. BBB ratings indicate that there is currently expectations of low credit risk. The
capacity for payment of financial commitments is considered adequate, but adverse changes in circumstances and economic conditions are more likely to impair this capacity. This is the lowest investment-grade category.
Speculative Grade
BB
Speculative. BB ratings indicate that there is a possibility of credit risk developing, particularly as
the result of adverse economic change over time; however, business or financial alternatives may be available to allow financial commitments to be met. Securities rated in this category are not investment grade.
B
Highly speculative. For issuers and performing obligations, B ratings indicate that significant credit
risk is present, but a limited margin of safety remains. Financial commitments are currently being met; however, capacity for continued payment is contingent upon a sustained, favorable business and economic environment. For individual obligations,
B ratings may indicate distressed or defaulted obligations with potential for extremely high recoveries. Such obligations would possess a Recovery Rating of R1 (outstanding).
CCC
For issuers and performing obligations, default is a real possibility. Capacity for meeting financial commitments is
solely reliant upon sustained, favorable business or economic conditions. For individual obligations, may indicate distressed or defaulted obligations with potential for average to superior levels of recovery. Differences in credit quality may be
denoted by plus/minus distinctions. Such obligations typically would possess a Recovery Rating of R2 (superior), or R3 (good) or R4 (average).
CC
For issuers and performing obligations, default of some kind appears probable. For individual obligations, may indicate
distressed or defaulted obligations with a Recovery Rating of R4 (average) or R5 (below average).
C
For issuers and performing obligations, default is imminent. For individual obligations, may indicate distressed or
defaulted obligations with potential for below-average to poor recoveries. Such obligations would possess a Recovery Rating of R6 (poor).
A-9
RD
Indicates an entity that has failed to make due payments (within the
applicable grace period) on some but not all material financial obligations, but continues to honor other classes of obligations.
D
Indicates an entity or sovereign that has defaulted on all of its financial obligations. Default generally is defined as one of the following: (i) failure of an obligor to make timely
payment of principal and/or interest under the contractual terms of any financial obligation; (ii) the bankruptcy filings, administration, receivership, liquidation or other winding-up or cessation of business of an obligor; or (iii) the
distressed or other coercive exchange of an obligation, where creditors were offered securities with diminished structural or economic terms compared with the existing obligation.
Default ratings are not assigned prospectively; within this context, non-payment on an instrument that contains a deferral feature or
grace period will not be considered a default until after the expiration of the deferral or grace period.
Issuers will be
rated D upon a default. Defaulted and distressed obligations typically are rated along the continuum of C to B ratings categories, depending upon their recovery prospects and other relevant characteristics.
Additionally, in structured finance transactions, where analysis indicates that an instrument is irrevocably impaired such that it is not expected to meet pay interest and/or principal in full in accordance with the terms of the obligations
documentation during the life of the transaction, but where no payment default in accordance with the terms of the documentation is imminent, the obligation may be rated in the B or CCC-C categories.
Default is determined by reference to the terms of the obligations documentation. Fitch will assign default ratings where it has
reasonably determined that payment has not been made on a material obligation in accordance with the requirements of the obligations documentation, or where it believes that default ratings consistent with Fitchs published definition of
default are the most appropriate ratings to assign.
Description of Fitch Ratings International Short-Term Credit Ratings:
International Short-Term Credit Ratings may also be referred to as Short-Term Ratings. The following ratings scale applies to
foreign currency and local currency ratings. A short-term rating has a time horizon of less than 13 months for most obligations, or up to three years for U.S. public finance, in line with industry standards, to reflect unique
characteristics of bond, tax, and revenue anticipation notes that are commonly issued with terms up to three years. Short-term ratings thus places greater emphasis on the liquidity necessary to meet financial commitments in a timely manner.
F1
Highest credit quality. Indicates the strongest capacity for timely payment of financial commitments; may
have an added + to denote any exceptionally strong credit feature.
F2
Good credit quality. A
satisfactory capacity for timely payment of financial commitments, but the margin of safety is not as great as in the case of the higher ratings.
F3
Fair credit quality. The capacity for timely payment of financial commitments is adequate; however, near-term adverse changes could result in a reduction to non-investment grade.
B
Speculative. Minimal capacity for timely payment of financial commitments, plus vulnerability to near-term
adverse changes in financial and economic conditions.
C
High default risk. Default is a real possibility.
Capacity for meeting financial commitments is solely reliant upon a sustained, favorable business and economic environment.
D
Default. Indicates an entity or sovereign that has defaulted on all of its financial obligations.
A-10
Notes to Fitch Ratings International Long-Term and Short-Term Credit Ratings:
The modifiers + or may be appended to a rating to denote relative status within major rating categories.
Such suffixes are not added to the AAA Long-term rating category, to categories below CCC, or to Short-term ratings other than F1. (The +/ modifiers are only used to denote issues within the CCC category,
whereas issuers are only rated CCC without the use of modifiers.)
Rating Watch: Ratings are placed on Rating Watch to
notify investors that there is a reasonable probability of a rating change and the likely direction of such change. These are designated as Positive, indicating a potential upgrade, Negative, for a potential downgrade, or
Evolving, if ratings may be raised, lowered or maintained. Rating Watch is typically resolved over a relatively short period.
Rating Outlook: An Outlook indicates the direction a rating is likely to move over a one to two-year period. Outlooks may be positive, stable or negative. A positive or negative Rating Outlook does
not imply a rating change is inevitable. Similarly, ratings for which outlooks are stable could be upgraded or downgraded before an outlook moves to positive or negative if circumstances warrant such an action. Occasionally, Fitch
Ratings may be unable to identify the fundamental trend. In these cases, the Rating Outlook may be described as evolving.
Program ratings (such as the those assigned to MTN shelf registrations) relate only to standard issues made under the program concerned;
it should not be assumed that these ratings apply to every issue made under the program. In particular, in the case of non-standard issues,
i.e.
, those that are linked to the credit of a third party or linked to the performance of an index,
ratings of these issues may deviate from the applicable program rating.
Variable rate demand obligations and other securities
which contain a short-term put or other similar demand feature will have a dual rating, such as AAA/F1+. The first rating reflects the ability to meet long-term principal and interest payments, whereas the second rating reflects the
ability to honor the demand feature in full and on time.
Interest Only: Interest Only ratings are assigned to interest
strips. These ratings do not address the possibility that a security holder might fail to recover some or all of its initial investment due to voluntary or involuntary principal repayments.
Principal Only: Principal Only ratings address the likelihood that a security holder will receive their initial principal investment
either before or by the scheduled maturity date.
Rate of Return: Ratings also may be assigned to gauge the likelihood of
an investor receiving a certain predetermined internal rate of return without regard to the precise timing of any cash flows.
PIF: Paid-in-Full; denotes a security that is paid-in-full, matured, called, or refinanced.
NR indicates that Fitch Ratings does not rate the issuer or issue in question.
Withdrawn: A rating is withdrawn when Fitch Ratings deems the amount of information available to be inadequate for rating
purposes, or when an obligation matures, is called, or refinanced, or for any other reason Fitch Ratings deems sufficient.
A-11
APPENDIX B
BATTERYMARCH FINANCIAL MANAGEMENT, INC.
PROXY VOTING POLICY AND GUIDELINES
INTRODUCTION
Batterymarch recognizes that proxy voting is an integral part
of its responsibilities as an investment manager. As a general principle, Batterymarch believes that proxies should be voted solely in the best interests of its clients. Batterymarchs primary focus and responsibility is to preserve and enhance
its clients investment returns. Accordingly, Batterymarch generally votes in favor of any proposal that maximizes shareholder wealth or expands shareholder rights and votes against any proposal that might decrease shareholder wealth or rights.
An integral part of this responsibility is encouraging good corporate governance practices by the companies we invest in through conscientiously exercising shareholder rights. We believe that, in the long term, this will result in increased value
for shareholders.
As required by Rule 206(4)-6 under the Investment Advisers Act of 1940, Batterymarch has adopted and
implemented the following written proxy voting policy and guidelines, which we believe are reasonably designed to ensure that Batterymarchs proxy votes are cast in a consistent manner that place our clients interests first.
VOTING AND MONITORING RESPONSIBILITY
Batterymarch has retained Institutional Shareholder Services, Inc. (ISS) to provide Batterymarch with day-to-day proxy voting services, including obtaining proxy ballots and providing vote
recommendations, in-depth research, voting, recordkeeping and reporting. ISS, an independent, recognized authority on proxy voting and corporate governance, is a subsidiary of MSCI Inc. Batterymarchs compliance personnel are responsible for
managing the relationship with ISS and ensuring that Batterymarchs proxy voting obligations are being properly met. ISS provides Batterymarch with periodic, customized reports and makes various other types of information available via its
web-based proxy voting platform in order that Batterymarch may monitor the votes cast by ISS on behalf of Batterymarchs clients.
VOTING AUTHORITY
Batterymarch assumes proxy voting authority for all client accounts unless a clients Investment Management Agreement explicitly
states otherwise.
HOW PROXIES ARE VOTED
For those client accounts for which Batterymarch is responsible for voting proxies, Batterymarchs policy is generally to vote in accordance with the recommendations of ISS. Voting will normally be
conducted in accordance with ISSs standard proxy voting guidelines. However, a client may direct Batterymarch to vote in accordance with the guidelines of Taft-Hartley Advisory Services, an independent research team of ISS which focuses on the
specific concerns of Taft-Hartley plans and which conform to the AFL-CIO Proxy Voting Guidelines. In instances where ISS has not made any vote recommendations with respect to a proxy, Batterymarch will generally vote in accordance with ISSs
proxy voting guidelines.
Under certain circumstances, Batterymarch may believe that it will be in the best interests of
clients to vote against ISSs recommendations or, in cases where ISS has not provided Batterymarch with any vote recommendations with respect to a proxy, to vote in contradiction with ISSs proxy voting guidelines. In such
B-1
cases, provided that Batterymarchs compliance personnel do not identify a material conflict of interest in overriding an ISS vote recommendation or voting against ISSs proxy voting
guidelines, Batterymarch may override the voting recommendation of ISS. Any votes cast against ISSs vote recommendations or in contradiction with ISSs proxy voting guidelines require pre-approval from Batterymarchs Chief Compliance
Officer.
Batterymarch will generally cast votes for all shares for which it has voting authority, unless the cost of voting
is presumed to outweigh the benefit. Batterymarchs policy regarding when it may not vote proxies is described below.
PROXY VOTING
GUIDELINES
ISSs proxy voting guidelines, which Batterymarch has adopted as its own, are considered an integral part
of this policy.
CONFLICTS OF INTEREST
Potential conflicts of interest may arise due to a variety of reasons that could affect how Batterymarch votes proxies. Batterymarch manages assets for a wide variety of clients that may have mutually
exclusive goals regarding the outcome of a shareholders meeting. Batterymarch may have a conflict of interest when a company that is soliciting a proxy is an advisory client of Batterymarch, or when Batterymarchs employees have an
interest in a proxy voting proposal that is at variance with the interests of Batterymarchs clients. Batterymarch attempts to mitigate material conflicts of interest by using pre-determined proxy voting guidelines and by obtaining vote
recommendations from ISS.
If one or more members of Batterymarchs investment teams believe that it will be in the best
interests of clients to vote in contradiction with ISSs vote recommendations or, in cases where ISS has not provided Batterymarch with any vote recommendations with respect to a proxy, to vote in contradiction with ISSs proxy voting
guidelines, Batterymarchs compliance personnel will be responsible for identifying whether such voting results in a material conflict of interest. Votes relating to proxy proposals that are considered routine, such as uncontested
elections of directors, meeting formalities, and approval of financial statements, generally will not result in a material conflict of interest. Material conflicts of interest are more likely to result from non-routine proxy proposals. Examples of
non-routine proxy proposals typically include any contested matter, such as a contested election of directors, a merger or sale of substantial assets, a change in the articles of incorporation that materially affects the rights of shareholders or a
compensation matter affecting company management (
e.g.
, stock option plans and retirement plans).
If Batterymarchs compliance
personnel determine that a material conflict of interest exists, Batterymarch may vote the proposal in accordance with either the recommendations of (a) ISS; (b) another authorized person of Batterymarch if the material conflict of
interest does not relate to such other person or Batterymarch itself; or (c) each client whose portfolio includes the applicable security. If Batterymarch solicits instructions from clients on how to vote a proxy proposal, Batterymarch may or
may not disclose to such clients the nature of the conflict of interest.
WHEN BATTERYMARCH MAY NOT VOTE
Batterymarch generally does not vote proxies when it presumes that the cost of voting outweighs its benefit. Voting in foreign markets
typically results in greater costs than voting in the United States. Among the various costs that may be associated with voting foreign shares includes share blocking in certain markets, fees for translating meeting materials written in foreign
languages, increased custodian bank fees and charges for obtaining power of attorney documents. We generally believe the most significant potential cost is the loss of liquidity resulting from the inability to sell securities when share blocking
restrictions apply.
B-2
Share blocking restrictions are designed to establish eligibility for voting and require
that shares be blocked from trading for a period of time before and/or after a shareholder meeting. During the blocking period, any pending trades in blocked shares will not settle. Depending on the market, this period can last from one day to
several weeks, assuming a quorum is achieved. If the first call for a meeting fails to meet quorum, it may be necessary to conduct a second or even third call, thereby extending the blocking period. If a sale of blocked shares must be executed to
satisfy a client redemption request or is otherwise deemed desirable by Batterymarch, it may settle late and potentially be subject to interest charges or other punitive fees or practices such as automatic buy-in procedures. In some markets, a
request can be made to unblock the shares before the meeting date, although there is no guarantee that this request will be successful.
Because of these inherent risks, we have decided not to vote when share blocking applies except in rare circumstances when Batterymarchs investment teams believe that a particular proposal or series
of proposals is likely to represent a substantial change to shareholder value and/or rights.
Certain of Batterymarchs
clients may participate in client-directed security lending programs. Under most lending arrangements, lenders must generally terminate the loan and recall the loaned securities in order to vote those securities, as the voting right would otherwise
belong to the borrower. In record date markets, such as the United States, the recall process must begin before the record date. In many foreign markets, the process of recalling shares in time to vote them is particularly difficult due to the
proximity of the record date to the meeting date, the timing of the receipt of information and administrative considerations. Often Batterymarch does not receive information about an upcoming vote until after the record date which is when issuers
typically mail their proxy statements. As a result, Batterymarch may learn of votes too late to arrange for a recall of shares lent through a clients custodian or other intermediary and to vote the proxies. As a result of these challenges,
securities that are on loan will generally not be voted.
RECORDKEEPING AND REPORTING
ISS maintains complete records of all votes cast on behalf of each of Batterymarchs client accounts. These records include the
number of shares held, meeting date, meeting type, management vote recommendation, vote(s) cast and the rationale for each vote. ISS provides Batterymarch with periodic, customized reports for each client account for which Batterymarch votes
proxies.
REQUESTS TO OBTAIN PROXY VOTING INFORMATION
Batterymarch provides proxy voting summary reports to clients or their representatives for whom Batterymarch exercises proxy voting responsibility on an annual basis or more frequently, if requested by
clients. Batterymarch also provides copies of its proxy voting guidelines to clients upon request.
Batterymarch generally
does not disclose information about its proxy voting policy and guidelines, portfolio holdings or specific details about its voting record to any party other than a client or their representative (unless as required by applicable law).
A log of client requests for proxy voting information and details on the fulfillment of those requests is maintained by
Batterymarchs compliance personnel.
Client requests for obtaining information about Batterymarchs proxy voting
guidelines or proxy voting record for securities held in client account portfolios may be obtained by contacting Batterymarchs Proxy Voting Manager at (617) 266-8300, or write to:
Batterymarch Financial Management, Inc.
Attention: Proxy Voting Manager
John Hancock Tower
200 Clarendon Street, 49
th
Floor
Boston, Massachusetts 02116 USA
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2012 U.S. Proxy Voting Summary Guidelines
January 31, 2012
Institutional Shareholder
Services Inc.
Copyright
©
2011 by ISS
www.issgovernance.com
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ISS 2012 U.S.
Proxy Voting Summary Guidelines
Effective for Meetings on or after Feb. 1, 2012
Published December 19, 2011
Updated January 31, 2012
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INTRODUCTION
The primary purpose of a public corporation is to create sustainable value for its shareowners. To that end, ISS designs its proxy voting
guidelines to enhance shareholders long-term economic interests. ISS Benchmark proxy voting guidelines serve as a tool to assist institutional investors in meeting their fiduciary requirements with respect to voting by promoting
shareholder value creation and risk mitigation at their portfolio firms.
ISS reviews and updates its proxy voting guidelines each year,
taking into account emerging issues and trends, the evolution of market standards, regulatory changes, and feedback provided by ISS institutional clients.
ISS robust and transparent
policy formulation process
includes an exhaustive review of relevant empirical studies and other factual data, an annual
policy survey
of institutional
clients and corporate issuers, policy roundtables with a wide range of industry constituents, and an open
comment period
on draft policy changes. ISS also conducts internal research to validate assumptions and policy positions.
The Benchmark Policy Guidelines consider market-specific recommended best practices, transparency, and disclosure when addressing issues such as board
structure, director accountability, corporate governance standards, executive compensation, shareholder rights, corporate transactions, and social/environmental issues.
ISS policy guidelines require the consideration of company-specific circumstances. When issuing a vote recommendation on a proposal, ISS considers historical operating and investment performance,
company disclosure (and proponent/dissident disclosure, if applicable), the companys governance structure and historical practices, and its industry.
In applying these policies, ISS often engages with public issuers, shareholders, activists, and other stakeholders to seek additional information and to gain insight and context in order to provide our
clients with informed vote recommendations. This engagement process enhances dialogue and promotes a higher level of understanding between investors and the companies in which they invest.
In formulating proxy voting policies, ISS assesses the potential costs and benefits of the adoption or rejection of the underlying ballot items. Where the economic impact of a ballot item is not apparent
and may involve trade-offs, the guidelines direct analysts to consider the economic consequences as well as potential risks to shareholders of approval.
This document presents a summary of all of ISS Benchmark U.S. Corporate Governance Policies. The document, along with other policy documents, is available on our Web site under the
Policy
Gateway
. If you have any questions, please contact Research Central at 301-556-0576 or
usresearch@issgovernance.com
.
These
policies will be effective for meetings on or after Feb. 1, 2012.
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Routine/Miscellaneous
Adjourn Meeting
Generally vote AGAINST proposals to provide management with the authority to adjourn an annual or special meeting absent compelling reasons to support the proposal.
Vote FOR proposals that relate specifically to soliciting votes for a merger or transaction if supporting that merger or transaction. Vote AGAINST
proposals if the wording is too vague or if the proposal includes other business.
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Amend Quorum Requirements
Vote AGAINST proposals to reduce quorum requirements for shareholder meetings below a majority of the shares outstanding unless there are compelling
reasons to support the proposal.
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Amend Minor Bylaws
Vote FOR bylaw or charter changes that are of a housekeeping nature (updates or corrections).
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Change Company Name
Vote FOR proposals to change the corporate name unless there is compelling evidence that the change would adversely impact shareholder value.
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Change Date, Time, or Location of Annual Meeting
Vote FOR management proposals to change the date, time, or location of the annual meeting unless the proposed change is unreasonable.
Vote AGAINST shareholder proposals to change the date, time, or location of the annual meeting unless the current scheduling or location is unreasonable.
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Other Business
Vote AGAINST proposals to approve other business when it appears as voting item.
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Audit-Related
Auditor Indemnification and Limitation of Liability
Vote CASE-BY-CASE on the issue of auditor indemnification and limitation of liability. Factors to be assessed include but are not limited to:
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The terms of the auditor agreementthe degree to which these agreements impact shareholders rights;
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The motivation and rationale for establishing the agreements;
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The quality of the companys disclosure; and
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Vote AGAINST or WITHHOLD from members of an audit committee in situations where there is persuasive evidence that the audit committee entered into an inappropriate indemnification agreement with its
auditor that limits the ability of the company, or its shareholders, to pursue legitimate legal recourse against the audit firm.
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Vote FOR proposals to ratify auditors unless any of the following apply:
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There is reason to believe that the independent auditor has rendered an opinion that is neither accurate nor indicative of the companys financial
position;
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Poor accounting practices are identified that rise to a serious level of concern, such as: fraud; misapplication of GAAP; and material weaknesses
identified in Section 404 disclosures; or
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Tax compliance and preparation include the preparation of original and amended tax returns and refund claims, and tax payment planning. All other
services in the tax category, such as tax advice, planning, or consulting, should be added to Other fees. If the breakout of tax fees cannot be determined, add all tax fees to Other fees.
In circumstances where Other fees include fees related to significant one-time capital structure events (such as initial public offerings,
bankruptcy emergence, and spin-offs) and the company makes public disclosure of the amount and nature of those fees that are an exception to the standard non-audit fee category, then such fees may be excluded from the non-audit fees
considered in determining the ratio of non-audit to audit/audit-related fees/tax compliance and preparation for purposes of determining whether non-audit fees are excessive.
u
u
u
u
u
Shareholder Proposals Limiting Non-Audit Services
Vote CASE-BY-CASE on shareholder proposals asking companies to prohibit or limit their auditors from engaging in non-audit services.
u
u
u
u
u
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-12
|
|
|
Shareholder
Proposals on Audit Firm Rotation
Vote CASE-BY-CASE on shareholder proposals asking for audit firm rotation, taking into account:
|
|
|
The tenure of the audit firm;
|
|
|
|
The length of rotation specified in the proposal;
|
|
|
|
Any significant audit-related issues at the company;
|
|
|
|
The number of Audit Committee meetings held each year;
|
|
|
|
The number of financial experts serving on the committee; and
|
|
|
|
Whether the company has a periodic renewal process where the auditor is evaluated for both audit quality and competitive price.
|
u
u
u
u
u
2. Board of Directors:
Voting on Director Nominees in Uncontested Elections
Votes on
director nominees should be determined CASE-BY-CASE.
Four fundamental principles apply when determining votes on director nominees:
|
1.
|
Board Accountability
: Practices that promote accountability include: transparency into a companys governance practices; annual board elections; and
providing shareholders the ability to remove problematic directors and to vote on takeover defenses or other charter/bylaw amendments. These practices help reduce the opportunity for management entrenchment.
|
|
2.
|
Board Responsiveness:
Directors should be responsive to shareholders, particularly in regard to shareholder proposals that receive a majority vote and to tender
offers where a majority of shares are tendered. Furthermore, shareholders should expect directors to devote sufficient time and resources to oversight of the company.
|
|
3.
|
Director Independence:
Without independence from management, the board may be unwilling or unable to effectively set company strategy and scrutinize performance
or executive compensation.
|
|
4.
|
Director Competence:
Companies should seek directors who can add value to the board through specific skills or expertise and who can devote sufficient time and
commitment to serve effectively. While directors should not be constrained by arbitrary limits such as age or term limits, directors who are unable to attend board and committee meetings or who are overextended (
i.e.
, serve on too many
boards) may be unable to effectively serve in shareholders best interests.
|
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|
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-13
|
|
|
1. Board
Accountability
Vote AGAINST
1
or WITHHOLD from the entire board of directors (except new nominees
2
, who should be considered CASE-BY-CASE) for the following:
Problematic Takeover Defenses
Classified Board Structure:
|
1.1.
|
The board is classified, and a continuing director responsible for a problematic governance issue at the board/committee level that would warrant a withhold/against
vote recommendation is not up for election. All appropriate nominees (except new) may be held accountable.
|
Director Performance Evaluation:
|
1.2.
|
The board lacks accountability and oversight, coupled with sustained poor performance relative to peers. Sustained poor performance is measured by one- and three-year
total shareholder returns in the bottom half of a companys four-digit GICS industry group (Russell 3000 companies only). Take into consideration the companys five-year total shareholder return and operational metrics. Problematic
provisions include but are not limited to:
|
|
|
|
A classified board structure;
|
|
|
|
A supermajority vote requirement;
|
|
|
|
Either a plurality vote standard in uncontested director elections or a majority vote standard with no plurality carve-out for contested elections;
|
|
|
|
The inability of shareholders to call special meetings;
|
|
|
|
The inability of shareholders to act by written consent;
|
|
|
|
A dual-class capital structure; and/or
|
|
|
|
A non-shareholder-approved poison pill.
|
Poison Pills:
|
1.3.
|
The companys poison pill has a dead-hand or modified dead-hand feature. Vote AGAINST or WITHHOLD from nominees every year until this
feature is removed;
|
|
1.4.
|
The board adopts a poison pill with a term of more than 12 months (long-term pill), or renews any existing pill, including any short-term pill
(12 months or less), without shareholder approval. A commitment or policy that puts a newly adopted pill to a binding shareholder vote may potentially offset an adverse vote recommendation. Review such companies with classified boards every year,
and such companies with annually elected boards at least once every three years, and vote AGAINST or WITHHOLD votes from all nominees if the company still maintains a non-shareholder-approved
|
1
|
In general, companies with a plurality vote standard use Withhold as the contrary vote option in director elections; companies with a majority vote standard
use Against. However, it will vary by company and the proxy must be checked to determine the valid contrary vote option for the particular company.
|
2
|
A new nominee is any current nominee who has not already been elected by shareholders and who joined the board after the problematic action in question
transpired. If ISS cannot determine whether the nominee joined the board before or after the problematic action transpired, the nominee will be considered a new nominee if he or she joined the board within the 12 months prior to the
upcoming shareholder meeting.
|
|
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|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-14
|
|
|
|
poison pill. This policy applies to all companies adopting or renewing pills after the announcement of this policy (Nov. 19, 2009); or
|
|
1.5.
|
The board makes a material adverse change to an existing poison pill without shareholder approval.
|
Vote CASE-BY-CASE on all nominees if:
|
1.6.
|
The board adopts a poison pill with a term of 12 months or less (short-term pill) without shareholder approval, taking into account the following factors:
|
|
|
|
The date of the pills adoption relative to the date of the next meeting of shareholders
i.e.
whether the company had time to put the
pill on ballot for shareholder ratification given the circumstances;
|
|
|
|
The issuers rationale;
|
|
|
|
The issuers governance structure and practices; and
|
|
|
|
The issuers track record of accountability to shareholders.
|
Problematic Audit-Related Practices
Generally vote AGAINST or WITHHOLD from the
members of the Audit Committee if:
|
1.7.
|
The non-audit fees paid to the auditor are excessive (see discussion under
Auditor Ratification
);
|
|
1.8.
|
The company receives an adverse opinion on the companys financial statements from its auditor; or
|
|
1.9.
|
There is persuasive evidence that the Audit Committee entered into an inappropriate indemnification agreement with its auditor that limits the ability of the company,
or its shareholders, to pursue legitimate legal recourse against the audit firm.
|
Vote CASE-BY-CASE on members of the Audit
Committee and potentially the full board if:
|
1.10.
|
Poor accounting practices are identified that rise to a level of serious concern, such as: fraud; misapplication of GAAP; and material weaknesses identified in
Section 404 disclosures. Examine the severity, breadth, chronological sequence and duration, as well as the companys efforts at remediation or corrective actions, in determining whether WITHHOLD/AGAINST votes are warranted.
|
Problematic Compensation Practices/Pay for Performance Misalignment
In the absence of an Advisory Vote on Executive Compensation ballot item or in egregious situations, vote AGAINST or WITHHOLD from the members of the
Compensation Committee and potentially the full board if:
|
1.11.
|
There is a significant misalignment between CEO pay and company performance (
pay for performance
);
|
|
1.12.
|
The company maintains significant
problematic pay practices
;
|
|
1.13.
|
The board exhibits a significant level of
poor communication and responsiveness
to shareholders;
|
|
1.14.
|
The company fails to submit one-time
transfers of stock options
to a shareholder vote; or
|
|
1.15.
|
The company fails to fulfill the terms of a
burn rate commitment
made to shareholders.
|
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-15
|
|
|
Vote CASE-BY-CASE on Compensation
Committee members (or, in exceptional cases, the full board) and the Management Say-on-Pay proposal if:
|
1.16.
|
The companys previous say-on-pay proposal received the support of less than 70 percent of votes cast, taking into account:
|
|
|
|
The companys response, including:
|
|
|
|
Disclosure of engagement efforts with major institutional investors regarding the issues that contributed to the low level of support;
|
|
|
|
Specific actions taken to address the issues that contributed to the low level of support;
|
|
|
|
Other recent compensation actions taken by the company;
|
|
|
|
Whether the issues raised are recurring or isolated;
|
|
|
|
The companys ownership structure; and
|
|
|
|
Whether the support level was less than 50 percent, which would warrant the highest degree of responsiveness.
|
Governance Failures
Under
extraordinary circumstances, vote AGAINST or WITHHOLD from directors individually, committee members, or the entire board, due to:
|
1.17.
|
Material failures of governance, stewardship, risk oversight, or fiduciary responsibilities at the company;
|
|
1.18.
|
Failure to replace management as appropriate; or
|
|
1.19.
|
Egregious actions related to a directors service on other boards that raise substantial doubt about his or her ability to effectively oversee management and serve
the best interests of shareholders at any company.
|
2. Board Responsiveness
Vote AGAINST or WITHHOLD from the entire board of directors (except new nominees, who should be considered CASE-BY-CASE) if:
|
2.1.
|
The board failed to act on a shareholder proposal that received the support of a majority of the shares outstanding the previous year;
|
|
2.2.
|
The board failed to act on a shareholder proposal that received the support of a majority of shares cast in the last year and one of the two previous years;
|
|
2.3.
|
The board failed to act on takeover offers where the majority of shares are tendered;
|
|
2.4.
|
At the previous board election, any director received more than 50 percent withhold/against votes of the shares cast and the company has failed to address the issue(s)
that caused the high withhold/against vote; or
|
|
2.5.
|
The board implements an advisory vote on executive compensation on a less frequent basis than the frequency that received the majority of votes cast at the most recent
shareholder meeting at which shareholders voted on the say-on-pay frequency.
|
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-16
|
|
|
Vote CASE-BY-CASE on the entire board if:
|
2.6.
|
The board implements an advisory vote on executive compensation on a less frequent basis than the frequency that received a plurality, but not a majority, of the votes
cast at the most recent shareholder meeting at which shareholders voted on the say-on-pay frequency, taking into account:
|
|
|
|
The boards rationale for selecting a frequency that is different from the frequency that received a plurality;
|
|
|
|
The companys ownership structure and vote results;
|
|
|
|
ISS analysis of whether there are compensation concerns or a history of problematic compensation practices; and
|
|
|
|
The previous years support level on the companys say-on-pay proposal.
|
3. Director Independence
Vote AGAINST or WITHHOLD from Inside Directors and Affiliated Outside Directors (per the Categorization of Directors) when:
|
3.1.
|
The inside or affiliated outside director serves on any of the three key committees: audit, compensation, or nominating;
|
|
3.2.
|
The company lacks an audit, compensation, or nominating committee so that the full board functions as that committee;
|
|
3.3.
|
The company lacks a formal nominating committee, even if the board attests that the independent directors fulfill the functions of such a committee; or
|
|
3.4.
|
Independent directors make up less than a majority of the directors.
|
4. Director Competence
Attendance at Board and Committee
Meetings:
Vote AGAINST or WITHHOLD from the entire board of directors (except new nominees, who should be considered CASE-BY-CASE) if:
|
4.1.
|
The companys proxy indicates that not all directors attended 75 percent of the aggregate board and committee meetings, but fails to provide the required
disclosure of the names of the director(s) involved.
|
Generally vote AGAINST or WITHHOLD from individual directors who:
|
4.2.
|
Attend less than 75 percent of the board and committee meetings (with the exception of new nominees). Acceptable reasons for director absences are generally limited to
the following:
|
|
|
|
Medical issues/illness;
|
|
|
|
Family emergencies; and
|
|
|
|
Missing only one meeting.
|
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-17
|
|
|
These reasons for
directors absences will only be considered by ISS if disclosed in the proxy or another SEC filing. If the disclosure is insufficient to determine whether a director attended at least 75 percent of board and committee meetings in aggregate,
vote AGAINST or WITHHOLD from the director.
Overboarded Directors:
Vote AGAINST or WITHHOLD from individual directors who:
|
4.3.
|
Sit on more than six public company boards; or
|
|
4.4.
|
Are CEOs of public companies who sit on the boards of more than two public companies besides their ownwithhold only at their outside boards.
|
u
u
u
u
u
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-18
|
|
|
2012 ISS
Categorization of Directors
|
1.1.
|
Employee of the company or one of its affiliates
i
.
|
|
1.2.
|
Among the five most highly paid individuals (excluding interim CEO).
|
|
1.3.
|
Listed as an officer as defined under Section 16 of the Securities and Exchange Act of 1934 (Section 16 officer)
ii
.
|
|
1.4.
|
Current interim CEO.
|
|
1.5.
|
Beneficial owner of more than 50 percent of the companys voting power (this may be aggregated if voting power is distributed among more than one member of a
defined group).
|
2.
|
Affiliated Outside Director (AO)
|
Board Attestation
|
2.1.
|
Board attestation that an outside director is not independent.
|
Former CEO
|
2.2.
|
Former CEO of the
company
iii
,iv
.
|
|
2.3.
|
Former CEO of an acquired company within the past five years
iv
.
|
|
2.4.
|
Former interim CEO if the service was longer than 18 months. If the service was between twelve and eighteen months an assessment of the interim
CEOs employment agreement will be
made
v
.
|
Non-CEO Executives
|
2.5.
|
Former Section 16 officer
ii
of the company, an affiliate
i
or
an acquired firm within the past five years.
|
|
2.6.
|
Section 16
officer
ii
of a former parent or predecessor firm at the time the company was sold or split off from the parent/predecessor within the past five years.
|
|
2.7.
|
Section 16
officer
ii
, former Section 16 officer, or general or limited partner of a joint venture or partnership with the company.
|
Family Members
|
2.8.
|
Immediate family
member
vi
of a current or former Section 16 officer
ii
of the company or its affiliates
i
within the last five years.
|
|
2.9.
|
Immediate family
member
vi
of a current employee of company or its affiliates
i
where additional factors raise concern (which may include, but are not limited to, the following: a director related to numerous
employees; the company or its affiliates employ relatives of numerous board members; or a non-Section 16 officer in a key strategic role).
|
Transactional, Professional, Financial, and Charitable Relationships
|
2.10.
|
Currently provides (or an immediate family member
vi
provides) professional services
vii
to the company, to an affiliate
i
of the company or an individual officer of the company or one of its affiliates in excess of $10,000 per year.
|
|
2.11.
|
Is (or an immediate family member
vi
is) a partner in, or a controlling shareholder or an
employee of, an organization which provides professional services
vii
to the company, to an affiliate
i
of the company, or an individual officer of the
company or one of its affiliates in excess of $10,000 per year.
|
|
2.12.
|
Has (or an immediate family member
vi
has) any material transactional relationship
viii
with the company or its affiliates
i
(excluding investments in the company through a private placement).
|
|
2.13.
|
Is (or an immediate family member
vi
is) a partner in, or a controlling shareholder or an
executive officer of, an organization which has any material transactional relationship
viii
with the company or its affiliates
i
(excluding investments in the company through a
private placement).
|
|
2.14.
|
Is (or an immediate family member
vi
is) a trustee, director, or employee of a charitable
or non-profit organization that receives material grants or endowments
viii
from the company or its affiliates
i
.
|
Other Relationships
|
2.15.
|
Party to a voting
agreement
ix
to vote in line with management on proposals being brought to shareholder vote.
|
|
2.16.
|
Has (or an immediate family member
vi
has) an interlocking relationship as defined by the
SEC involving members of the board of directors or its Compensation Committee
x
.
|
|
2.17.
|
Founder
xi
of the company but not currently an employee.
|
|
2.18.
|
Any
material
xii
relationship with the company.
|
3.
|
Independent Outside Director (IO)
|
|
3.1.
|
No
material
xii
connection to the company other than a board seat.
|
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-19
|
|
|
Footnotes:
i
Affiliate includes a subsidiary, sibling company, or parent company. ISS uses 50 percent control ownership by the parent company as the standard for applying its affiliate
designation.
ii
Section 16 officer (officers subject to
Section 16 of the Securities and Exchange Act of 1934) includes the chief executive, operating, financial, legal, technology, and accounting officers of a company (including the president, treasurer, secretary, controller, or any vice president
in charge of a principal business unit, division, or policy function). A non-employee director serving as an officer due to statutory requirements (
e.g.,
corporate secretary) will be classified as an Affiliated Outsider. If the company
provides explicit disclosure that the director is not receiving additional compensation in excess of $10,000 per year for serving in that capacity, then the director will be classified as an Independent Outsider.
iii
Includes any former CEO of the company prior to the
companys initial public offering (IPO).
iv
When there is a former CEO of a special purpose
acquisition company (SPAC) serving on the board of an acquired company, ISS will generally classify that director as independent unless determined otherwise taking into account the following factors: the applicable listing standards determination of
such directors independence; any operating ties to the firm; and the existence of any other conflicting relationships or related party transactions.
v
ISS will look at the terms of the interim CEOs
employment contract to determine whether it contains severance pay, long-term health and pension benefits, or other such standard provisions typically contained in contracts of permanent, non-temporary CEOs. ISS will also consider whether a formal
search process was underway for a full-time CEO at the time.
vi
Immediate family member follows the SECs definition of such and covers spouses, parents, children, step-parents, step-children, siblings, in-laws, and any person
(other than a tenant or employee) sharing the household of any director, nominee for director, executive officer, or significant shareholder of the company.
vii
Professional services can be characterized as
advisory in nature, generally involve access to sensitive company information or to strategic decision-making, and typically have a commission- or fee-based payment structure. Professional services generally include, but are not limited to the
following: investment banking/financial advisory services; commercial banking (beyond deposit services); investment services; insurance services; accounting/audit services; consulting services; marketing services; legal services; property management
services; realtor services; lobbying services; executive search services; and IT consulting services. The following would generally be considered transactional relationships and not professional services: deposit services; IT tech support services;
educational services; and construction services. The case of participation in a banking syndicate by a non-lead bank should be considered a transactional (and hence subject to the associated materiality test) rather than a professional relationship.
Of Counsel relationships are only considered immaterial if the individual does not receive any form of compensation (in excess of $10,000 per year) from, or is a retired partner of, the firm providing the professional service. The case
of a company providing a professional service to one of its directors or to an entity with which one of its directors is affiliated will be considered a transactional rather than a professional relationship. Insurance services and marketing services
are assumed to be professional services unless the company explains why such services are not advisory.
viii
A material transactional relationship, including
grants to non-profit organizations, exists if the company makes annual payments to, or receives annual payments from, another entity exceeding the greater of $200,000 or 5 percent of the recipients gross revenues, in the case of a company
which follows NASDAQ listing standards; or the greater of $1,000,000 or 2 percent of the recipients gross revenues, in the case of a company which follows NYSE/Amex listing standards. In the case of a company that follows neither of the
preceding standards, ISS will apply the NASDAQ-based materiality test. (The recipient is the party receiving the financial proceeds from the transaction.)
ix
Dissident directors who are parties to a voting
agreement pursuant to a settlement arrangement will generally be classified as independent unless determined otherwise, taking into account the following factors: the terms of the agreement; the duration of the standstill provision in the agreement;
the limitations and requirements of actions that are agreed upon; whether the dissident director nominee(s) is subject to the standstill; and whether there any conflicting relationships or related party transactions.
x
Interlocks include: executive officers serving as
directors on each others compensation or similar committees (or, in the absence of such a committee, on the board); or executive officers sitting on each others boards and at least one serves on the others compensation or similar
committee (or, in the absence of such a committee, on the board).
xi
The operating involvement of the founder with the company will be considered. Little to no operating involvement may cause ISS to deem the founder as an independent outsider.
xii
For purposes of ISS director independence
classification, material will be defined as a standard of relationship (financial, personal, or otherwise) that a reasonable person might conclude could potentially influence ones objectivity in the boardroom in a manner that would
have a meaningful impact on an individuals ability to satisfy requisite fiduciary standards on behalf of shareholders.
u
u
u
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u
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-20
|
|
|
Other
Board-Related Proposals
Age/Term Limits
Vote AGAINST management and shareholder proposals to limit the tenure of outside directors through mandatory retirement ages.
Vote AGAINST management proposals to limit the tenure of outside directors through term limits. However, scrutinize boards where the average tenure of all directors exceeds 15 years for independence from
management and for sufficient turnover to ensure that new perspectives are being added to the board.
u
u
u
u
u
Board Size
Vote FOR proposals seeking to fix the board size or designate a range for the board size.
Vote AGAINST proposals that give management the ability to alter the size of the board outside of a specified range without shareholder approval.
u
u
u
u
u
Classification/Declassification of the Board
Vote AGAINST proposals to classify (stagger) the board.
Vote FOR proposals to repeal classified
boards and to elect all directors annually.
u
u
u
u
u
CEO Succession Planning
Generally vote FOR proposals seeking disclosure on a CEO succession planning policy, considering at a minimum, the following factors:
|
|
|
The reasonableness/scope of the request; and
|
|
|
|
The companys existing disclosure on its current CEO succession planning process.
|
u
u
u
u
u
Cumulative Voting
Generally vote AGAINST proposals to eliminate cumulative voting.
Generally vote FOR shareholder
proposals to restore or provide for cumulative voting unless:
|
|
|
The company has proxy access, thereby allowing shareholders to nominate directors to the companys ballot; and
|
|
|
|
The company has adopted a majority vote standard, with a carve-out for plurality voting in situations where there are more nominees than seats, and a
director resignation policy to address failed elections.
|
Vote FOR proposals for cumulative voting at controlled companies
(insider voting power > 50%).
u
u
u
u
u
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-21
|
|
|
Director
and Officer Indemnification and Liability Protection
Vote CASE-BY-CASE on proposals on director and officer indemnification and liability
protection using Delaware law as the standard.
Vote AGAINST proposals that would:
|
|
|
Eliminate entirely directors and officers liability for monetary damages for violating the duty of care.
|
|
|
|
Expand coverage beyond just legal expenses to liability for acts, such as negligence, that are more serious violations of fiduciary obligation than
mere carelessness.
|
|
|
|
Expand the scope of indemnification to provide for mandatory indemnification of company officials in connection with acts that previously the
company was permitted to provide indemnification for, at the discretion of the companys board (
i.e.
, permissive indemnification), but that previously the company was not required to indemnify.
|
Vote FOR only those proposals providing such expanded coverage in cases when a directors or officers legal
defense was unsuccessful if both of the following apply:
|
|
|
If the director was found to have acted in good faith and in a manner that he reasonably believed was in the best interests of the company; and
|
|
|
|
If only the directors legal expenses would be covered.
|
u
u
u
u
u
Establish/Amend Nominee Qualifications
Vote CASE-BY-CASE on proposals that establish or amend director qualifications. Votes should be based on the reasonableness of the criteria and the degree to which they may preclude dissident nominees
from joining the board.
Vote CASE-BY-CASE on shareholder resolutions seeking a director nominee who possesses a particular subject matter
expertise, considering:
|
|
|
The companys board committee structure, existing subject matter expertise, and board nomination provisions relative to that of its peers;
|
|
|
|
The companys existing board and management oversight mechanisms regarding the issue for which board oversight is sought;
|
|
|
|
The companys disclosure and performance relating to the issue for which board oversight is sought and any significant related controversies; and
|
|
|
|
The scope and structure of the proposal.
|
u
u
u
u
u
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-22
|
|
|
Establish
Other Board Committee Proposals
Generally vote AGAINST shareholder proposals to establish a new board committee, as such proposals seek a
specific oversight mechanism/structure that potentially limits a companys flexibility to determine an appropriate oversight mechanism for itself. However, the following factors will be considered:
|
|
|
Existing oversight mechanisms (including current committee structure) regarding the issue for which board oversight is sought;
|
|
|
|
Level of disclosure regarding the issue for which board oversight is sought;
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Company performance related to the issue for which board oversight is sought;
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Board committee structure compared to that of other companies in its industry sector; and
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The scope and structure of the proposal.
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Filling Vacancies/Removal of Directors
Vote AGAINST proposals that provide that directors may be removed only for cause.
Vote FOR
proposals to restore shareholders ability to remove directors with or without cause.
Vote AGAINST proposals that provide that only
continuing directors may elect replacements to fill board vacancies.
Vote FOR proposals that permit shareholders to elect directors to fill
board vacancies.
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Independent Chair (Separate Chair/CEO)
Generally vote FOR shareholder proposals requiring that the chairmans position be filled by an independent director, unless the company satisfies
all
of the following criteria:
The company maintains the following counterbalancing governance structure:
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Designated lead director, elected by and from the independent board members with clearly delineated and comprehensive duties. (The role may
alternatively reside with a presiding director, vice chairman, or rotating lead director; however, the director must serve a minimum of one year in order to qualify as a lead director.) The duties should include, but are not limited to, the
following:
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presides at all meetings of the board at which the chairman is not present, including executive sessions of the independent directors;
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serves as liaison between the chairman and the independent directors;
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approves information sent to the board;
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approves meeting agendas for the board;
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approves meeting schedules to assure that there is sufficient time for discussion of all agenda items;
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
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B-23
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has the authority to call meetings of the independent directors;
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if requested by major shareholders, ensures that he or she is available for consultation and direct communication;
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Two-thirds independent board;
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Fully independent key committees;
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Established governance guidelines;
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A company in the Russell 3000 universe must not have exhibited sustained poor total shareholder return (TSR) performance, defined as one- and
three-year TSR in the bottom half of the companys four-digit GICS industry group (using Russell 3000 companies only), unless there has been a change in the Chairman/CEO position within that time. For companies not in the Russell 3000 universe,
the company must not have underperformed both its peers and index on the basis of both one-year and three-year total shareholder returns, unless there has been a change in the Chairman/CEO position within that time;
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The company does not have any problematic governance or management issues, examples of which include, but are not limited to:
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Egregious compensation practices;
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Multiple related-party transactions or other issues putting director independence at risk;
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Corporate or management scandals;
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Excessive problematic corporate governance provisions; or
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Flagrant actions by management or the board with potential or realized negative impacts on shareholders.
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Majority of Independent Directors/Establishment of Independent Committees
Vote FOR shareholder proposals asking that a majority or more of directors be independent unless the board composition already meets the proposed
threshold by ISS definition of independent outsider. (See
Categorization of Directors
.)
Vote FOR shareholder proposals asking
that board audit, compensation, and/or nominating committees be composed exclusively of independent directors unless they currently meet that standard.
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Majority Vote Standard for the Election of Directors
Generally vote FOR management proposals to adopt a majority of votes cast standard for directors in uncontested elections. Vote AGAINST if no carve-out for a plurality vote standard in contested elections
is included.
Generally vote FOR precatory and binding shareholder resolutions requesting that the board change the companys bylaws to
stipulate that directors need to be elected with an affirmative majority of votes cast, provided it does not conflict with the state law where the company is incorporated. Binding resolutions need to allow for a carve-out for a plurality vote
standard when there are more nominees than board seats.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-24
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Companies are strongly encouraged to also
adopt a post-election policy (also known as a director resignation policy) that will provide guidelines so that the company will promptly address the situation of a holdover director.
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Proxy Access
ISS supports proxy access as an important shareholder right, one that is complementary to other best-practice corporate governance features. However, in
the absence of a uniform standard, proposals to enact proxy access may vary widely; as such, ISS is not setting forth specific parameters at this time and will take a case-by-case approach in evaluating these proposals.
Vote CASE-BY-CASE on proposals to enact proxy access, taking into account, among other factors:
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Company-specific factors; and
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Proposal-specific factors, including:
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The ownership thresholds proposed in the resolution (
i.e.
, percentage and duration);
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The maximum proportion of directors that shareholders may nominate each year; and
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The method of determining which nominations should appear on the ballot if multiple shareholders submit nominations.
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Require More Nominees than Open Seats
Vote AGAINST shareholder proposals that would require a company to nominate more candidates than the number of open board seats.
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Shareholder Engagement Policy (Shareholder Advisory Committee)
Generally vote FOR shareholder proposals requesting that the board establish an internal mechanism/process, which may include a committee, in order to
improve communications between directors and shareholders, unless the company has the following features, as appropriate:
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Established a communication structure that goes beyond the exchange requirements to facilitate the exchange of information between shareholders and
members of the board;
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Effectively disclosed information with respect to this structure to its shareholders;
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Company has not ignored majority-supported shareholder proposals or a majority withhold vote on a director nominee; and
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The company has an independent chairman or a lead director, according to ISS definition. This individual must be made available for periodic
consultation and direct communication with major shareholders.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-25
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Proxy
ContestsVoting for Director Nominees in Contested Elections
Vote CASE-BY-CASE on the election of directors in contested elections,
considering the following factors:
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Long-term financial performance of the target company relative to its industry;
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Managements track record;
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Background to the proxy contest;
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Qualifications of director nominees (both slates);
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Strategic plan of dissident slate and quality of critique against management;
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Likelihood that the proposed goals and objectives can be achieved (both slates);
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Stock ownership positions.
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Vote-No Campaigns
In cases where companies are targeted in connection with public vote-no campaigns, evaluate director nominees under the existing governance policies for voting on director nominees in
uncontested elections. Take into consideration the arguments submitted by shareholders and other publicly available information.
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3. Shareholder Rights & Defenses
Advance Notice Requirements for Shareholder Proposals/Nominations
Vote CASE-BY-CASE on advance notice proposals, giving support to those proposals which allow shareholders to submit proposals/nominations as close to the meeting date as reasonably possible and within the
broadest window possible, recognizing the need to allow sufficient notice for company, regulatory and shareholder review.
To be reasonable,
the companys deadline for shareholder notice of a proposal/ nominations must not be more than 60 days prior to the meeting, with a submittal window of at least 30 days prior to the deadline. The submittal window is the period under which a
shareholder must file his proposal/nominations prior to the deadline.
In general, support additional efforts by companies to ensure full
disclosure in regard to a proponents economic and voting position in the company so long as the informational requirements are reasonable and aimed at providing shareholders with the necessary information to review such proposals.
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Amend Bylaws without Shareholder Consent
Vote AGAINST proposals giving the board exclusive authority to amend the bylaws.
Vote FOR
proposals giving the board the ability to amend the bylaws in addition to shareholders.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
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B-26
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Confidential Voting
Vote FOR shareholder proposals requesting that corporations adopt confidential voting, use independent vote tabulators, and use independent inspectors of election, as long as the proposal includes a
provision for proxy contests as follows: In the case of a contested election, management should be permitted to request that the dissident group honor its confidential voting policy. If the dissidents agree, the policy remains in place. If the
dissidents will not agree, the confidential voting policy is waived.
Vote FOR management proposals to adopt confidential voting.
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Control Share Acquisition Provisions
Control share acquisition statutes function by denying shares their voting rights when they contribute to ownership in excess of certain thresholds. Voting rights for those shares exceeding ownership
limits may only be restored by approval of either a majority or supermajority of disinterested shares. Thus, control share acquisition statutes effectively require a hostile bidder to put its offer to a shareholder vote or risk voting
disenfranchisement if the bidder continues buying up a large block of shares.
Vote FOR proposals to opt out of control share acquisition
statutes unless doing so would enable the completion of a takeover that would be detrimental to shareholders.
Vote AGAINST proposals to amend
the charter to include control share acquisition provisions.
Vote FOR proposals to restore voting rights to the control shares.
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Control Share Cash-Out Provisions
Control share cash-out statutes give dissident shareholders the right to cash-out of their position in a company at the expense of the shareholder who has taken a control position. In other
words, when an investor crosses a preset threshold level, remaining shareholders are given the right to sell their shares to the acquirer, who must buy them at the highest acquiring price.
Vote FOR proposals to opt out of control share cash-out statutes.
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Disgorgement Provisions
Disgorgement provisions require an acquirer or potential acquirer of more than a certain percentage of a companys stock to disgorge, or pay back, to the company any profits realized from the sale of
that companys stock purchased 24 months before achieving control status. All sales of company stock by the acquirer occurring within a certain period of time (between 18 months and 24 months) prior to the investors gaining control status
are subject to these recapture-of-profits provisions.
Vote FOR proposals to opt out of state disgorgement provisions.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-27
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Exclusive
Venue
Vote CASE-BY-CASE on exclusive venue proposals, taking into account:
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Whether the company has been materially harmed by shareholder litigation outside its jurisdiction of incorporation, based on disclosure in the
companys proxy statement; and
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Whether the company has the following good governance features:
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An annually elected board;
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A majority vote standard in uncontested director elections; and
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The absence of a poison pill, unless the pill was approved by shareholders.
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Fair Price Provisions
Vote CASE-BY-CASE on proposals to adopt fair price provisions (provisions that stipulate that an acquirer must pay the same price to acquire all shares as it paid to acquire the control shares),
evaluating factors such as the vote required to approve the proposed acquisition, the vote required to repeal the fair price provision, and the mechanism for determining the fair price.
Generally, vote AGAINST fair price provisions with shareholder vote requirements greater than a majority of disinterested shares.
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Freeze-Out Provisions
Vote FOR proposals to opt out of state freeze-out provisions. Freeze-out provisions force an investor who surpasses a certain ownership threshold in a company to wait a specified period of time before
gaining control of the company.
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Greenmail
Greenmail payments are targeted share repurchases by management of company stock from individuals or groups seeking control of the company. Since only the hostile party receives payment, usually at a
substantial premium over the market value of its shares, the practice discriminates against all other shareholders.
Vote FOR proposals to
adopt anti-greenmail charter or bylaw amendments or otherwise restrict a companys ability to make greenmail payments.
Vote CASE-BY-CASE
on anti-greenmail proposals when they are bundled with other charter or bylaw amendments.
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Net Operating Loss (NOL) Protective Amendments
Vote AGAINST proposals to adopt a protective amendment for the stated purpose of protecting a companys net operating losses (NOL) if the effective
term of the protective amendment would exceed the shorter of three years and the exhaustion of the NOL.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
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B-28
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Vote CASE-BY-CASE, considering the
following factors, for management proposals to adopt an NOL protective amendment that would remain in effect for the shorter of three years (or less) and the exhaustion of the NOL:
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The ownership threshold (NOL protective amendments generally prohibit stock ownership transfers that would result in a new 5-percent holder or increase
the stock ownership percentage of an existing 5-percent holder);
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Shareholder protection mechanisms (sunset provision or commitment to cause expiration of the protective amendment upon exhaustion or expiration of the
NOL);
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The companys existing governance structure including: board independence, existing takeover defenses, track record of responsiveness to
shareholders, and any other problematic governance concerns; and
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Any other factors that may be applicable.
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Poison Pills (Shareholder Rights Plans)
Shareholder Proposals to Put Pill to a Vote and/or Adopt a Pill Policy
Vote FOR shareholder proposals requesting that the company submit its poison pill to a shareholder vote or redeem it UNLESS the company has: (1) A shareholder approved poison pill in place; or
(2) The company has adopted a policy concerning the adoption of a pill in the future specifying that the board will only adopt a shareholder rights plan if either:
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Shareholders have approved the adoption of the plan; or
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The board, in its exercise of its fiduciary responsibilities, determines that it is in the best interest of shareholders under the circumstances to
adopt a pill without the delay in adoption that would result from seeking stockholder approval (
i.e.
, the fiduciary out provision). A poison pill adopted under this fiduciary out will be put to a shareholder ratification vote
within 12 months of adoption or expire. If the pill is not approved by a majority of the votes cast on this issue, the plan will immediately terminate.
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If the shareholder proposal calls for a time period of less than 12 months for shareholder ratification after adoption, vote FOR the proposal, but add the caveat that a vote within 12 months would be
considered sufficient implementation.
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Management Proposals to Ratify a Poison Pill
Vote CASE-BY-CASE on management proposals on poison pill ratification, focusing on the features of the shareholder rights plan. Rights plans should
contain the following attributes:
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No lower than a 20% trigger, flip-in or flip-over;
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A term of no more than three years;
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No dead-hand, slow-hand, no-hand or similar feature that limits the ability of a future board to redeem the pill;
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Shareholder redemption feature (qualifying offer clause); if the board refuses to redeem the pill 90 days after a qualifying offer is announced, 10
percent of the shares may call a special meeting or seek a written consent to vote on rescinding the pill.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
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B-29
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In addition, the rationale for adopting
the pill should be thoroughly explained by the company. In examining the request for the pill, take into consideration the companys existing governance structure, including: board independence, existing takeover defenses, and any problematic
governance concerns.
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Management Proposals to Ratify a Pill to Preserve Net Operating Losses (NOLs)
Vote AGAINST proposals to adopt a poison pill for the stated purpose of protecting a companys net operating losses (NOL) if the term of the pill
would exceed the shorter of three years and the exhaustion of the NOL.
Vote CASE-BY-CASE on management proposals for poison pill
ratification, considering the following factors, if the term of the pill would be the shorter of three years (or less) and the exhaustion of the NOL:
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The ownership threshold to transfer (NOL pills generally have a trigger slightly below 5 percent);
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Shareholder protection mechanisms (sunset provision, or commitment to cause expiration of the pill upon exhaustion or expiration of NOLs);
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The companys existing governance structure including: board independence, existing takeover defenses, track record of responsiveness to
shareholders, and any other problematic governance concerns; and
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Any other factors that may be applicable.
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Reimbursing Proxy Solicitation Expenses
Vote CASE-BY-CASE on proposals to reimburse proxy solicitation expenses. When voting in conjunction with support of a dissident slate, vote FOR the reimbursement of all appropriate proxy solicitation
expenses associated with the election.
Generally vote FOR shareholder proposals calling for the reimbursement of reasonable costs incurred in
connection with nominating one or more candidates in a contested election where the following apply:
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The election of fewer than 50% of the directors to be elected is contested in the election;
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One or more of the dissidents candidates is elected;
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Shareholders are not permitted to cumulate their votes for directors; and
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The election occurred, and the expenses were incurred, after the adoption of this bylaw.
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Reincorporation Proposals
Management or shareholder proposals to change a companys state of incorporation should be evaluated CASE-BY-CASE, giving consideration to both financial and corporate governance concerns including
the following:
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Reasons for reincorporation;
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Comparison of companys governance practices and provisions prior to and following the reincorporation; and
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Comparison of corporation laws of original state and destination state.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
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B-30
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Vote FOR reincorporation when the economic
factors outweigh any neutral or negative governance changes.
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Shareholder Ability to Act by Written Consent
Generally vote AGAINST management and shareholder proposals to restrict or prohibit shareholders ability to act by written consent.
Generally vote FOR management and shareholder proposals that provide shareholders with the ability to act by written consent, taking into account the
following factors:
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Shareholders current right to act by written consent;
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The inclusion of exclusionary or prohibitive language;
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Investor ownership structure; and
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Shareholder support of, and managements response to, previous shareholder proposals.
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Vote CASE-BY-CASE on shareholder proposals if, in addition to the considerations above, the company has the following governance and antitakeover
provisions:
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An
unfettered
3
right for shareholders to call special
meetings at a 10 percent threshold;
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A majority vote standard in uncontested director elections;
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No non-shareholder-approved pill; and
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An annually elected board.
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Shareholder Ability to Call Special Meetings
Vote AGAINST management or shareholder proposals to restrict or prohibit shareholders ability to call special meetings.
Generally vote FOR management or shareholder proposals that provide shareholders with the ability to call special meetings taking into account the following factors:
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Shareholders current right to call special meetings;
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Minimum ownership threshold necessary to call special meetings (10% preferred);
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The inclusion of exclusionary or prohibitive language;
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Investor ownership structure; and
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Shareholder support of, and managements response to, previous shareholder proposals.
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3
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Unfettered means no restrictions on agenda items, no restrictions on the number of shareholders who can group together to reach the 10 percent threshold,
and only reasonable limits on when a meeting can be called: no greater than 30 days after the last annual meeting and no greater than 90 prior to the next annual meeting.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-31
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Stakeholder
Provisions
Vote AGAINST proposals that ask the board to consider non-shareholder constituencies or other non-financial effects when
evaluating a merger or business combination.
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State Antitakeover Statutes
Vote CASE-BY-CASE on proposals to opt in or out of state takeover statutes (including fair price provisions, stakeholder laws, poison pill endorsements, severance pay and labor contract provisions, and
anti-greenmail provisions).
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Supermajority Vote Requirements
Vote AGAINST proposals to require a supermajority shareholder vote.
Vote FOR management or
shareholder proposals to reduce supermajority vote requirements. However, for companies with shareholder(s) who have significant ownership levels, vote CASE-BY-CASE, taking into account:
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Quorum requirements; and
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4. CAPITAL/RESTRUCTURING
Capital
Adjustments to Par
Value of Common Stock
Vote FOR management proposals to reduce the par value of common stock unless the action is being taken to facilitate
an anti-takeover device or some other negative corporate governance action
Vote FOR management proposals to eliminate par value.
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Common Stock Authorization
Vote FOR proposals to increase the number of authorized common shares where the primary purpose of the increase is to issue shares in connection with a transaction on the same ballot that warrants
support.
Vote AGAINST proposals at companies with more than one class of common stock to increase the number of authorized shares of the
class of common stock that has superior voting rights.
Vote AGAINST proposals to increase the number of authorized common shares if a vote
for a reverse stock split on the same ballot is warranted despite the fact that the authorized shares would not be reduced proportionally.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-32
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Vote CASE-BY-CASE on all other proposals
to increase the number of shares of common stock authorized for issuance. Take into account company-specific factors that include, at a minimum, the following:
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Past Board Performance:
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The companys use of authorized shares during the last three years
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Disclosure in the proxy statement of the specific purposes of the proposed increase;
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Disclosure in the proxy statement of specific and severe risks to shareholders of not approving the request; and
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The dilutive impact of the request as determined by an allowable increase calculated by ISS (typically 100 percent of existing authorized shares) that
reflects the companys need for shares and total shareholder returns.
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Dual Class Structure
Generally vote AGAINST proposals to create a new class of common stock unless:
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The company discloses a compelling rationale for the dual-class capital structure, such as:
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The companys auditor has concluded that there is substantial doubt about the companys ability to continue as a going concern; or
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The new class of shares will be transitory;
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The new class is intended for financing purposes with minimal or no dilution to current shareholders in both the short term and long term; and
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The new class is not designed to preserve or increase the voting power of an insider or significant shareholder.
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Issue Stock for Use with Rights Plan
Vote AGAINST proposals that increase authorized common stock for the explicit purpose of implementing a non-shareholder- approved shareholder rights plan (poison pill).
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Preemptive Rights
Vote CASE-BY-CASE on shareholder proposals that seek preemptive rights, taking into consideration:
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The size of the company;
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The shareholder base; and
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The liquidity of the stock.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
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B-33
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Preferred
Stock Authorization
Vote FOR proposals to increase the number of authorized preferred shares where the primary purpose of the increase is
to issue shares in connection with a transaction on the same ballot that warrants support.
Vote AGAINST proposals at companies with more than
one class or series of preferred stock to increase the number of authorized shares of the class or series of preferred stock that has superior voting rights.
Vote CASE-BY-CASE on all other proposals to increase the number of shares of preferred stock authorized for issuance. Take into account company-specific factors that include, at a minimum, the following:
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Past Board Performance:
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The companys use of authorized preferred shares during the last three years;
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Disclosure in the proxy statement of the specific purposes for the proposed increase;
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Disclosure in the proxy statement of specific and severe risks to shareholders of not approving the request;
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In cases where the company has existing authorized preferred stock, the dilutive impact of the request as determined by an allowable increase
calculated by ISS (typically 100 percent of existing authorized shares) that reflects the companys need for shares and total shareholder returns; and
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Whether the shares requested are blank check preferred shares that can be used for antitakeover purposes.
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Recapitalization Plans
Vote CASE-BY-CASE on recapitalizations (reclassifications of securities), taking into account the following:
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More simplified capital structure;
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Fairness of conversion terms;
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Impact on voting power and dividends;
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Reasons for the reclassification;
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Conflicts of interest; and
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Other alternatives considered.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
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B-34
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Reverse
Stock Splits
Vote FOR management proposals to implement a reverse stock split when the number of authorized shares will be
proportionately reduced.
Vote AGAINST proposals when there is not a proportionate reduction of authorized shares, unless:
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A stock exchange has provided notice to the company of a potential delisting; or
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The effective increase in authorized shares is equal to or less than the allowable increase calculated in accordance with ISS Common Stock
Authorization policy.
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Share Repurchase Programs
Vote FOR management proposals to institute open-market share repurchase plans in which all shareholders may participate on equal terms.
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Stock Distributions: Splits and Dividends
Vote FOR management proposals to increase the common share authorization for a stock split or share dividend, provided that the increase in authorized shares equal to or less than the allowable increase
calculated in accordance with ISS Common Stock Authorization policy.
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Tracking Stock
Vote CASE-BY-CASE on the creation of tracking stock, weighing the strategic value of the transaction against such factors as:
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Adverse governance changes;
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Excessive increases in authorized capital stock;
|
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|
Unfair method of distribution;
|
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|
|
Diminution of voting rights;
|
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|
|
Adverse conversion features;
|
|
|
|
Negative impact on stock option plans; and
|
|
|
|
Alternatives such as spin-off.
|
u
u
u
u
u
Restructuring
Appraisal Rights
Vote FOR proposals to restore or provide
shareholders with rights of appraisal.
u
u
u
u
u
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-35
|
|
|
Asset
Purchases
Vote CASE-BY-CASE on asset purchase proposals, considering the following factors:
|
|
|
Financial and strategic benefits;
|
|
|
|
How the deal was negotiated;
|
|
|
|
Other alternatives for the business;
|
u
u
u
u
u
Asset Sales
Vote CASE-BY-CASE on asset sales, considering the following factors:
|
|
|
Impact on the balance sheet/working capital;
|
|
|
|
Potential elimination of diseconomies;
|
|
|
|
Anticipated financial and operating benefits;
|
|
|
|
Anticipated use of funds;
|
|
|
|
Value received for the asset;
|
|
|
|
How the deal was negotiated;
|
u
u
u
u
u
Bundled Proposals
Vote CASE-BY-CASE on bundled or conditional proxy proposals. In the case of items that are conditioned upon each other, examine the benefits and costs of the packaged items. In instances when
the joint effect of the conditioned items is not in shareholders best interests, vote AGAINST the proposals. If the combined effect is positive, support such proposals.
u
u
u
u
u
Conversion of Securities
Vote CASE-BY-CASE on proposals regarding conversion of securities. When evaluating these proposals the investor should review the dilution to existing shareholders, the conversion price relative to market
value, financial issues, control issues, termination penalties, and conflicts of interest.
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-36
|
|
|
Vote FOR the conversion if it is expected
that the company will be subject to onerous penalties or will be forced to file for bankruptcy if the transaction is not approved.
u
u
u
u
u
Corporate Reorganization/Debt Restructuring/Prepackaged Bankruptcy Plans/Reverse Leveraged Buyouts/Wrap Plans
Vote CASE-BY-CASE on proposals to increase common and/or preferred shares and to issue shares as part of a debt restructuring plan, after
evaluating:
|
|
|
Dilution to existing shareholders positions;
|
|
|
|
Terms of the offerdiscount/premium in purchase price to investor, including any fairness opinion; termination penalties; exit strategy;
|
|
|
|
Financial issuescompanys financial situation; degree of need for capital; use of proceeds; effect of the financing on the companys
cost of capital;
|
|
|
|
Managements efforts to pursue other alternatives;
|
|
|
|
Control issueschange in management; change in control, guaranteed board and committee seats; standstill provisions; voting agreements; veto power
over certain corporate actions; and
|
|
|
|
Conflict of interestarms length transaction, managerial incentives.
|
Vote FOR the debt restructuring if it is expected that the company will file for bankruptcy if the transaction is not approved.
u
u
u
u
u
Formation of Holding Company
Vote CASE-BY-CASE on proposals regarding the formation of a holding company, taking into consideration the following:
|
|
|
The reasons for the change;
|
|
|
|
Any financial or tax benefits;
|
|
|
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Increases in capital structure; and
|
|
|
|
Changes to the articles of incorporation or bylaws of the company.
|
Absent compelling financial reasons to recommend the transaction, vote AGAINST the formation of a holding company if the transaction would include either of the following:
|
|
|
Increases in common or preferred stock in excess of the allowable maximum (see discussion under Capital); or
|
|
|
|
Adverse changes in shareholder rights.
|
u
u
u
u
u
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-37
|
|
|
Going
Private and Going Dark Transactions (LBOs and Minority Squeeze-outs)
Vote CASE-BY-CASE on going private transactions, taking into account
the following:
|
|
|
How the deal was negotiated;
|
|
|
|
Other alternatives/offers considered; and
|
Vote
CASE-BY-CASE on going dark transactions, determining whether the transaction enhances shareholder value by taking into consideration:
|
|
|
Whether the company has attained benefits from being publicly-traded (examination of trading volume, liquidity, and market research of the stock);
|
|
|
|
Balanced interests of continuing vs. cashed-out shareholders, taking into account the following:
|
|
|
|
Are all shareholders able to participate in the transaction?
|
|
|
|
Will there be a liquid market for remaining shareholders following the transaction?
|
|
|
|
Does the company have strong corporate governance?
|
|
|
|
Will insiders reap the gains of control following the proposed transaction?
|
|
|
|
Does the state of incorporation have laws requiring continued reporting that may benefit shareholders?
|
u
u
u
u
u
Joint Ventures
Vote CASE-BY-CASE on proposals to form joint ventures, taking into account the following:
|
|
|
Percentage of assets/business contributed;
|
|
|
|
Financial and strategic benefits;
|
|
|
|
Other alternatives; and
|
u
u
u
u
u
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-38
|
|
|
Liquidations
Vote CASE-BY-CASE on liquidations, taking into account the following:
|
|
|
Managements efforts to pursue other alternatives;
|
|
|
|
Appraisal value of assets; and
|
|
|
|
The compensation plan for executives managing the liquidation.
|
Vote FOR the liquidation if the company will file for bankruptcy if the proposal is not approved.
u
u
u
u
u
Mergers and Acquisitions
Vote CASE-BY-CASE on mergers and acquisitions. Review and evaluate the merits and drawbacks of the proposed transaction, balancing various and sometimes countervailing factors including:
|
|
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Valuation
Is the value to be received by the target shareholders (or paid by the acquirer) reasonable? While the fairness opinion may
provide an initial starting point for assessing valuation reasonableness, emphasis is placed on the offer premium, market reaction and strategic rationale.
|
|
|
|
Market reaction
How has the market responded to the proposed deal? A negative market reaction should cause closer scrutiny of a deal.
|
|
|
|
Strategic rationale
Does the deal make sense strategically? From where is the value derived? Cost and revenue synergies should not be
overly aggressive or optimistic, but reasonably achievable. Management should also have a favorable track record of successful integration of historical acquisitions.
|
|
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Negotiations and process
Were the terms of the transaction negotiated at arms-length? Was the process fair and equitable? A fair
process helps to ensure the best price for shareholders. Significant negotiation wins can also signify the deal makers competency. The comprehensiveness of the sales process (
e.g.
, full auction, partial auction, no auction)
can also affect shareholder value.
|
|
|
|
Conflicts of interest
Are insiders benefiting from the transaction disproportionately and inappropriately as compared to non-insider
shareholders? As the result of potential conflicts, the directors and officers of the company may be more likely to vote to approve a merger than if they did not hold these interests. Consider whether these interests may have influenced these
directors and officers to support or recommend the merger. The CIC figure presented in the ISS Transaction Summary section of this report is an aggregate figure that can in certain cases be a misleading indicator of the true value
transfer from shareholders to insiders. Where such figure appears to be excessive, analyze the underlying assumptions to determine whether a potential conflict exists.
|
|
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|
Governance
Will the combined company have a better or worse governance profile than the current governance profiles of the respective
parties to the transaction? If the governance profile is to change for the worse, the burden is on the company to prove that other issues (such as valuation) outweigh any deterioration in governance.
|
u
u
u
u
u
|
|
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|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-39
|
|
|
Private
Placements/Warrants/Convertible Debentures
Vote CASE-BY-CASE on proposals regarding private placements, warrants, and convertible
debentures taking into consideration:
|
|
|
Dilution to existing shareholders position: The amount and timing of shareholder ownership dilution should be weighed against the needs and
proposed shareholder benefits of the capital infusion. Although newly issued common stock, absent preemptive rights, is typically dilutive to existing shareholders, share price appreciation is often the necessary event to trigger the exercise of
out of the money warrants and convertible debt. In these instances from a value standpoint, the negative impact of dilution is mitigated by the increase in the companys stock price that must occur to trigger the dilutive event.
|
|
|
|
Terms of the offer (discount/premium in purchase price to investor, including any fairness opinion, conversion features, termination penalties, exit
strategy):
|
|
|
|
The terms of the offer should be weighed against the alternatives of the company and in light of companys financial condition. Ideally, the
conversion price for convertible debt and the exercise price for warrants should be at a premium to the then prevailing stock price at the time of private placement.
|
|
|
|
When evaluating the magnitude of a private placement discount or premium, consider factors that influence the discount or premium, such as, liquidity,
due diligence costs, control and monitoring costs, capital scarcity, information asymmetry and anticipation of future performance.
|
|
|
|
The companys financial condition;
|
|
|
|
Degree of need for capital;
|
|
|
|
Effect of the financing on the companys cost of capital;
|
|
|
|
Current and proposed cash burn rate;
|
|
|
|
Going concern viability and the state of the capital and credit markets.
|
|
|
|
Managements efforts to pursue alternatives and whether the company engaged in a process to evaluate alternatives: A fair, unconstrained process
helps to ensure the best price for shareholders. Financing alternatives can include joint ventures, partnership, merger or sale of part or all of the company.
|
|
|
|
Guaranteed board and committee seats;
|
|
|
|
Veto power over certain corporate actions; and
|
|
|
|
Minority versus majority ownership and corresponding minority discount or majority control premium
|
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-40
|
|
|
|
|
|
Conflicts of interest should be viewed from the perspective of the company and the investor.
|
|
|
|
Were the terms of the transaction negotiated at arms length? Are managerial incentives aligned with shareholder interests?
|
|
|
|
The markets response to the proposed deal. A negative market reaction is a cause for concern. Market reaction may be addressed by analyzing
the one day impact on the unaffected stock price.
|
Vote FOR the private placement, or FOR the issuance of warrants and/or
convertible debentures in a private placement, if it is expected that the company will file for bankruptcy if the transaction is not approved.
u
u
u
u
u
Reorganization/Restructuring Plan (Bankruptcy)
Vote CASE-BY-CASE on proposals to common shareholders on bankruptcy plans of reorganization, considering the following factors including, but not limited to:
|
|
|
Estimated value and financial prospects of the reorganized company;
|
|
|
|
Percentage ownership of current shareholders in the reorganized company;
|
|
|
|
Whether shareholders are adequately represented in the reorganization process (particularly through the existence of an Official Equity Committee);
|
|
|
|
The cause(s) of the bankruptcy filing, and the extent to which the plan of reorganization addresses the cause(s);
|
|
|
|
Existence of a superior alternative to the plan of reorganization; and
|
|
|
|
Governance of the reorganized company.
|
u
u
u
u
u
Special Purpose Acquisition Corporations (SPACs)
Vote CASE-BY-CASE on SPAC mergers and acquisitions taking into account the following:
|
|
|
ValuationIs the value being paid by the SPAC reasonable? SPACs generally lack an independent fairness opinion and the financials on the target
may be limited. Compare the conversion price with the intrinsic value of the target company provided in the fairness opinion. Also, evaluate the proportionate value of the combined entity attributable to the SPAC IPO shareholders versus the
pre-merger value of SPAC. Additionally, a private company discount may be applied to the target, if it is a private entity.
|
|
|
|
Market reactionHow has the market responded to the proposed deal? A negative market reaction may be a cause for concern. Market
reaction may be addressed by analyzing the one-day impact on the unaffected stock price.
|
|
|
|
Deal timingA main driver for most transactions is that the SPAC charter typically requires the deal to be complete within 18 to 24 months,
or the SPAC is to be liquidated. Evaluate the valuation, market reaction, and potential conflicts of interest for deals that are announced close to the liquidation date.
|
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-41
|
|
|
|
|
|
Negotiations and processWhat was the process undertaken to identify potential target companies within specified industry or location specified in
charter? Consider the background of the sponsors.
|
|
|
|
Conflicts of interestHow are sponsors benefiting from the transaction compared to IPO shareholders? Potential conflicts could arise if a fairness
opinion is issued by the insiders to qualify the deal rather than a third party or if management is encouraged to pay a higher price for the target because of an 80% rule (the charter requires that the fair market value of the target is at
least equal to 80% of net assets of the SPAC). Also, there may be sense of urgency by the management team of the SPAC to close the deal since its charter typically requires a transaction to be completed within the 18-24 month timeframe.
|
|
|
|
Voting agreementsAre the sponsors entering into enter into any voting agreements/ tender offers with shareholders who are likely to vote AGAINST
the proposed merger or exercise conversion rights?
|
|
|
|
GovernanceWhat is the impact of having the SPAC CEO or founder on key committees following the proposed merger?
|
u
u
u
u
u
Spin-offs
Vote CASE-BY-CASE on spin-offs, considering:
|
|
|
Tax and regulatory advantages;
|
|
|
|
Planned use of the sale proceeds;
|
|
|
|
Benefits to the parent company;
|
|
|
|
Corporate governance changes;
|
|
|
|
Changes in the capital structure.
|
u
u
u
u
u
Value Maximization Shareholder Proposals
Vote CASE-BY-CASE on shareholder proposals seeking to maximize shareholder value by:
|
|
|
Hiring a financial advisor to explore strategic alternatives;
|
|
|
|
Selling the company; or
|
|
|
|
Liquidating the company and distributing the proceeds to shareholders.
|
These proposals should be evaluated based on the following factors:
|
|
|
Prolonged poor performance with no turnaround in sight;
|
|
|
|
Signs of entrenched board and management (such as the adoption of takeover defenses);
|
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-42
|
|
|
|
|
|
Strategic plan in place for improving value;
|
|
|
|
Likelihood of receiving reasonable value in a sale or dissolution; and
|
|
|
|
The company actively exploring its strategic options, including retaining a financial advisor.
|
u
u
u
u
u
5. COMPENSATION
Executive Pay Evaluation
Underlying all evaluations are five
global principles that most investors expect corporations to adhere to in designing and administering executive and director compensation programs:
|
1.
|
Maintain appropriate pay-for-performance alignment, with emphasis on long-term shareholder value: This principle encompasses overall executive pay practices, which must
be designed to attract, retain, and appropriately motivate the key employees who drive shareholder value creation over the long term. It will take into consideration, among other factors, the link between pay and performance; the mix between fixed
and variable pay; performance goals; and equity-based plan costs;
|
|
2.
|
Avoid arrangements that risk pay for failure: This principle addresses the appropriateness of long or indefinite contracts, excessive severance packages,
and guaranteed compensation;
|
|
3.
|
Maintain an independent and effective compensation committee: This principle promotes oversight of executive pay programs by directors with appropriate skills,
knowledge, experience, and a sound process for compensation decision-making (
e.g.
, including access to independent expertise and advice when needed);
|
|
4.
|
Provide shareholders with clear, comprehensive compensation disclosures: This principle underscores the importance of informative and timely disclosures that enable
shareholders to evaluate executive pay practices fully and fairly;
|
|
5.
|
Avoid inappropriate pay to non-executive directors: This principle recognizes the interests of shareholders in ensuring that compensation to outside directors does not
compromise their independence and ability to make appropriate judgments in overseeing managers pay and performance. At the market level, it may incorporate a variety of generally accepted best practices.
|
Advisory Votes on Executive CompensationManagement Proposals (Management Say-on-Pay)
Vote CASE-BY-CASE on ballot items related to executive pay and practices, as well as certain aspects of outside director compensation.
Vote AGAINST Advisory Votes on Executive Compensation (Management Say-on-PayMSOP) if:
|
|
|
There is a significant misalignment between CEO pay and company performance (
pay for performance
);
|
|
|
|
The company maintains significant
problematic pay practices
;
|
|
|
|
The board exhibits a significant level of
poor communication and responsiveness
to shareholders.
|
Vote AGAINST or WITHHOLD from the members of the Compensation Committee and potentially the full board if:
|
|
|
There is no MSOP on the ballot, and an AGAINST vote on an MSOP is warranted due to pay for performance misalignment, problematic pay practices, or the
lack of adequate responsiveness on compensation issues raised previously, or a combination thereof;
|
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-43
|
|
|
|
|
|
The board fails to respond adequately to a previous MSOP proposal that received less than 70 percent support of votes cast;
|
|
|
|
The company has recently practiced or approved problematic pay practices, including option repricing or option backdating; or
|
|
|
|
The situation is egregious.
|
Vote AGAINST an equity plan on the ballot if:
|
|
|
A pay for performance misalignment is found, and a significant portion of the CEOs misaligned pay is attributed to non-performance-based equity
awards, taking into consideration:
|
|
|
|
Magnitude of pay misalignment;
|
|
|
|
Contribution of non-performance-based equity grants to overall pay; and
|
|
|
|
The proportion of equity awards granted in the last three fiscal years concentrated at the named executive officer (NEO) level.
|
Primary Evaluation Factors for Executive Pay
Pay-for-Performance Evaluation
ISS annually conducts a
pay-for-performance analysis to identify strong or satisfactory alignment between pay and performance over a sustained period. With respect to companies in the Russell 3000 index, this analysis considers the following:
|
1.
|
Peer Group
4
Alignment:
|
|
|
|
The degree of alignment between the companys TSR rank and the CEOs total pay rank within a peer group, as measured over one-year and
three-year periods (weighted 40/60);
|
|
|
|
The multiple of the CEOs total pay relative to the peer group median.
|
|
2.
|
Absolute Alignment: The absolute alignment between the trend in CEO pay and company TSR over the prior five fiscal years
i.e.
, the difference between the
trend in annual pay changes and the trend in annualized TSR during the period.
|
If the above analysis demonstrates significant
unsatisfactory long-term pay-for-performance alignment or, in the case of non-Russell 3000 index companies, misaligned pay and performance are otherwise suggested, analyze the following qualitative factors to determine how various pay elements may
work to encourage or to undermine long-term value creation and alignment with shareholder interests:
|
|
|
The ratio of performance-to time-based equity awards;
|
|
|
|
The ratio of performance-based compensation to overall compensation;
|
|
|
|
The completeness of disclosure and rigor of performance goals;
|
|
|
|
The companys peer group benchmarking practices;
|
4
|
The peer group is generally comprised of 14-24 companies that are selected using market cap, revenue (or assets for financial firms), and GICS industry group, via a
process designed to select peers that are closest to the subject company, and where the subject company is close to median in revenue/asset size. The relative alignment evaluation will consider the companys rank for both pay and TSR within the
peer group (for one- and three-year periods) and the CEOs pay relative to the median pay level in the peer group.
|
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-44
|
|
|
|
|
|
Actual results of financial/operational metrics, such as growth in revenue, profit, cash flow, etc., both absolute and relative to peers;
|
|
|
|
Special circumstances related to, for example, a new CEO in the prior fiscal year or anomalous equity grant practices (
e.g.
, biennial awards);
and
|
|
|
|
Any other factors deemed relevant.
|
Problematic Pay Practices
The focus is on executive
compensation practices that contravene the global pay principles, including:
|
|
|
Problematic practices related to non-performance-based compensation elements;
|
|
|
|
Incentives that may motivate excessive risk-taking; and
|
Problematic Pay Practices related to Non-Performance-Based Compensation Elements
Pay elements that are not directly based on performance are generally evaluated CASE-BY-CASE considering the context of a companys overall pay program and demonstrated pay-for-performance
philosophy. Please refer to ISS Compensation FAQ document for detail on specific pay practices that have been identified as potentially problematic and may lead to negative recommendations if they are deemed to be inappropriate or unjustified
relative to executive pay best practices. The list below highlights the problematic practices that carry significant weight in this overall consideration and may result in adverse vote recommendations:
|
|
|
Repricing or replacing of underwater stock options/SARS without prior shareholder approval (including cash buyouts and voluntary surrender of
underwater options);
|
|
|
|
Excessive perquisites or tax gross-ups, including any gross-up related to a secular trust or restricted stock vesting;
|
|
|
|
New or extended agreements that provide for:
|
|
|
|
CIC payments exceeding 3 times base salary and average/target/most recent bonus;
|
|
|
|
CIC severance payments without involuntary job loss or substantial diminution of duties (single or modified single triggers);
|
|
|
|
CIC payments with excise tax gross-ups (including modified gross-ups).
|
Incentives that may Motivate Excessive Risk-Taking
|
|
|
Multi-year guaranteed bonuses;
|
|
|
|
A single or common performance metric used for short- and long-term plans;
|
|
|
|
Lucrative severance packages;
|
|
|
|
High pay opportunities relative to industry peers;
|
|
|
|
Disproportionate supplemental pensions; or
|
|
|
|
Mega annual equity grants that provide unlimited upside with no downside risk.
|
Factors that potentially mitigate the impact of risky incentives include rigorous claw-back provisions and robust stock ownership/holding guidelines.
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-45
|
|
|
Options Backdating
The following factors should be examined CASE-BY-CASE to allow for distinctions to be made between sloppy plan administration versus
deliberate action or fraud:
|
|
|
Reason and motive for the options backdating issue, such as inadvertent vs. deliberate grant date changes;
|
|
|
|
Duration of options backdating;
|
|
|
|
Size of restatement due to options backdating;
|
|
|
|
Corrective actions taken by the board or compensation committee, such as canceling or re-pricing backdated options, the recouping of option gains on
backdated grants; and
|
|
|
|
Adoption of a grant policy that prohibits backdating, and creates a fixed grant schedule or window period for equity grants in the future.
|
Board Communications and Responsiveness
Consider the following factors CASE-BY-CASE when evaluating ballot items related to executive pay on the boards responsiveness to investor input and
engagement on compensation issues:
|
|
|
Failure to respond to majority-supported shareholder proposals on executive pay topics; or
|
|
|
|
Failure to adequately respond to the companys previous say-on-pay proposal that received the support of less than 70 percent of votes cast,
taking into account:
|
|
|
|
The companys response, including:
|
|
|
|
Disclosure of engagement efforts with major institutional investors regarding the issues that contributed to the low level of support;
|
|
|
|
Specific actions taken to address the issues that contributed to the low level of support;
|
|
|
|
Other recent compensation actions taken by the company;
|
|
|
|
Whether the issues raised are recurring or isolated;
|
|
|
|
The companys ownership structure; and
|
|
|
|
Whether the support level was less than 50 percent, which would warrant the highest degree of responsiveness.
|
u
u
u
u
u
Frequency of Advisory Vote on Executive Compensation (Say When on Pay)
Vote FOR annual advisory votes on compensation, which provide the most consistent and clear communication channel for shareholder concerns about
companies executive pay programs.
u
u
u
u
u
Voting on Golden Parachutes in an Acquisition, Merger, Consolidation, or Proposed Sale
Vote CASE-BY-CASE on proposals to approve the companys golden parachute compensation, consistent with ISS policies on problematic pay
practices related to severance packages. Features that may lead to a vote AGAINST include:
|
|
|
Recently adopted or materially amended agreements that include excise tax gross-up provisions (since prior annual meeting);
|
|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-46
|
|
|
|
|
|
Recently adopted or materially amended agreements that include modified single triggers (since prior annual meeting);
|
|
|
|
Single trigger payments that will happen immediately upon a change in control, including cash payment and such items as the acceleration of
performance-based equity despite the failure to achieve performance measures;
|
|
|
|
Single-trigger vesting of equity based on a definition of change in control that requires only shareholder approval of the transaction (rather than
consummation);
|
|
|
|
Potentially excessive severance payments;
|
|
|
|
Recent amendments or other changes that may make packages so attractive as to influence merger agreements that may not be in the best interests of
shareholders;
|
|
|
|
In the case of a substantial gross-up from pre-existing/grandfathered contract: the element that triggered the gross-up (
i.e.
, option
mega-grants at low point in stock price, unusual or outsized payments in cash or equity made or negotiated prior to the merger); or
|
|
|
|
The companys assertion that a proposed transaction is conditioned on shareholder approval of the golden parachute advisory vote. ISS would view
this as problematic from a corporate governance perspective.
|
In cases where the golden parachute vote is incorporated into
a companys separate advisory vote on compensation (management say on pay), ISS will evaluate the say on pay proposal in accordance with these guidelines, which may give higher weight to that component of the
overall evaluation.
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Equity-Based and Other Incentive Plans
Vote CASE-BY-CASE on equity-based compensation plans. Vote AGAINST the equity plan if any of the following factors apply:
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The total
cost
of the companys equity plans is unreasonable;
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The plan expressly permits
repricing
;
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A
pay-for-performance misalignment
is found;
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The companys three year burn rate exceeds the
burn rate cap
of its industry group;
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The plan has a
liberal change-of-control definition
; or
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The plan is a vehicle for
problematic pay practices
.
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Each of these factors is described below:
Cost of Equity Plans
Generally, vote AGAINST equity plans if the cost is unreasonable. For non-employee director plans, vote FOR the plan if certain factors
are met (see Director Compensation section).
The cost of the equity plans is expressed as Shareholder Value Transfer (SVT), which is measured
using a binomial option pricing model that assesses the amount of shareholders equity flowing out of the company to
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-47
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employees and directors. SVT is expressed as both a dollar amount and as a percentage of market value, and includes the new shares proposed, shares available under existing plans, and shares
granted but unexercised. All award types are valued. For omnibus plans, unless limitations are placed on the most expensive types of awards (for example, full value awards), the assumption is made that all awards to be granted will be the most
expensive types. See discussion of specific types of awards.
The Shareholder Value Transfer is reasonable if it falls below the
company-specific allowable cap. The allowable cap is determined as follows: The top quartile performers in each industry group (using the Global Industry Classification Standard: GICS) are identified. Benchmark SVT levels for each industry are
established based on these top performers historic SVT. Regression analyses are run on each industry group to identify the variables most strongly correlated to SVT. The benchmark industry SVT level is then adjusted upwards or downwards for
the specific company by plugging the company-specific performance measures, size and cash compensation into the industry cap equations to arrive at the companys allowable cap.
Repricing Provisions
Vote AGAINST plans that expressly permit
the repricing or exchange of underwater stock options/stock appreciate rights (SARs) without prior shareholder approval. Repricing includes the ability to do any of the following:
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Amend the terms of outstanding options or SARs to reduce the exercise price of such outstanding options or SARs;
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Cancel outstanding options or SARs in exchange for options or SARs with an exercise price that is less than the exercise price of the original options
or SARs.
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Also, vote AGAINST OR WITHHOLD from members of the Compensation Committee who approved and/or implemented a
repricing or an option/SAR exchange program, by buying out underwater options/SARs for stock, cash or other consideration or canceling underwater options/SARs and regranting options/SARs with a lower exercise price, without prior shareholder
approval, even if such repricings are allowed in their equity plan.
Vote AGAINST plans if the company has a history of repricing without
shareholder approval, and the applicable listing standards would not preclude them from doing so.
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Pay-for-Performance MisalignmentApplication to Equity
Plans
If a significant portion of the CEOs misaligned pay is attributed to non-performance-based equity awards, and there is an
equity plan on the ballot with the CEO as one of the participants, ISS may recommend a vote AGAINST the equity plan. Considerations in voting AGAINST the equity plan may include, but are not limited to:
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Magnitude of pay misalignment;
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Contribution of non-performance-based equity grants to overall pay; and
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The proportion of equity awards granted in the last three fiscal years concentrated at the named executive officer level.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-48
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Three-Year
Burn Rate/Burn Rate Commitment
Generally vote AGAINST equity plans for companies whose average three-year burn rates their burn rate caps.
Burn rate caps are calculated as the greater of: (1) the mean (µ) plus one standard deviation (ó) of the
companys GICS group segmented by Russell 3000 index and non-Russell 3000 index (per the Burn Rate Table published in December); and (2) two percent of weighted common shares outstanding. In addition, year-over-year burn-rate cap changes
will be limited to a maximum of two (2) percentage points (plus or minus) the prior years burn-rate cap.
If a company fails to
fulfill a burn rate commitment, vote AGAINST or WITHHOLD from the compensation committee.
In the absence of demonstrating reasonable use of
equity awards under the first burn rate commitment, companies making consecutive burn rate commitments may not garner support on their proposed equity plan proposals.
Burn Rate Table for 2012
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Russell 3000
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Non-Russell 3000
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GICS
|
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Description
|
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Mean
|
|
|
Standard
Deviation
|
|
|
2012 Burn
Rate Cap*
|
|
|
Mean
|
|
|
Standard
Deviation
|
|
|
2012 Burn
Rate Cap*
|
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1010
|
|
Energy
|
|
|
1.99
|
%
|
|
|
2.03
|
%
|
|
|
4.02
|
%
|
|
|
2.82
|
%
|
|
|
4.64
|
%
|
|
|
7.46
|
%
|
1510
|
|
Materials
|
|
|
1.64
|
%
|
|
|
1.44
|
%
|
|
|
3.08
|
%
|
|
|
2.48
|
%
|
|
|
3.56
|
%
|
|
|
6.04
|
%
|
2010
|
|
Capital Goods
|
|
|
1.72
|
%
|
|
|
1.21
|
%
|
|
|
2.93
|
%
|
|
|
3.53
|
%
|
|
|
5.29
|
%
|
|
|
*8.69
|
%
|
2020
|
|
Commercial Services & Supplies
|
|
|
2.52
|
%
|
|
|
2.09
|
%
|
|
|
4.61
|
%
|
|
|
2.88
|
%
|
|
|
2.93
|
%
|
|
|
5.81
|
%
|
2030
|
|
Transportation
|
|
|
1.68
|
%
|
|
|
1.15
|
%
|
|
|
2.83
|
%
|
|
|
1.51
|
%
|
|
|
1.37
|
%
|
|
|
2.88
|
%
|
2510
|
|
Automobiles & Components
|
|
|
1.85
|
%
|
|
|
1.55
|
%
|
|
|
3.40
|
%
|
|
|
4.48
|
%
|
|
|
6.32
|
%
|
|
|
*6.99
|
%
|
2520
|
|
Consumer Durables & Apparel
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|
|
2.84
|
%
|
|
|
1.96
|
%
|
|
|
4.81
|
%
|
|
|
2.81
|
%
|
|
|
3.46
|
%
|
|
|
6.27
|
%
|
2530
|
|
Consumer Services
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|
2.70
|
%
|
|
|
3.11
|
%
|
|
|
5.81
|
%
|
|
|
2.81
|
%
|
|
|
4.18
|
%
|
|
|
6.99
|
%
|
2540
|
|
Media
|
|
|
2.91
|
%
|
|
|
2.65
|
%
|
|
|
5.56
|
%
|
|
|
2.75
|
%
|
|
|
2.91
|
%
|
|
|
5.65
|
%
|
2550
|
|
Retailing
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|
2.43
|
%
|
|
|
1.59
|
%
|
|
|
4.02
|
%
|
|
|
3.38
|
%
|
|
|
4.70
|
%
|
|
|
*6.62
|
%
|
3010, 3020,
3030
|
|
Consumer Staples
|
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|
1.64
|
%
|
|
|
1.39
|
%
|
|
|
3.03
|
%
|
|
|
3.18
|
%
|
|
|
6.61
|
%
|
|
|
*7.17
|
%
|
3510
|
|
Health Care Equipment & Services
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|
2.95
|
%
|
|
|
1.74
|
%
|
|
|
4.69
|
%
|
|
|
5.23
|
%
|
|
|
7.28
|
%
|
|
|
*11.92
|
%
|
3520
|
|
Pharmaceuticals & Biotechnology
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3.59
|
%
|
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|
3.90
|
%
|
|
|
7.49
|
%
|
|
|
6.01
|
%
|
|
|
8.02
|
%
|
|
|
*12.58
|
%
|
4010
|
|
Banks
|
|
|
1.31
|
%
|
|
|
1.50
|
%
|
|
|
2.81
|
%
|
|
|
1.20
|
%
|
|
|
2.29
|
%
|
|
|
3.49
|
%
|
4020
|
|
Diversified Financials
|
|
|
5.02
|
%
|
|
|
5.97
|
%
|
|
|
*9.15
|
%
|
|
|
4.78
|
%
|
|
|
6.52
|
%
|
|
|
11.31
|
%
|
4030
|
|
Insurance
|
|
|
1.58
|
%
|
|
|
1.22
|
%
|
|
|
2.80
|
%
|
|
|
0.69
|
%
|
|
|
0.98
|
%
|
|
|
*2.31
|
%
|
4040
|
|
Real Estate
|
|
|
1.15
|
%
|
|
|
1.19
|
%
|
|
|
2.34
|
%
|
|
|
1.35
|
%
|
|
|
2.11
|
%
|
|
|
3.46
|
%
|
4510
|
|
Software & Services
|
|
|
4.41
|
%
|
|
|
3.35
|
%
|
|
|
7.76
|
%
|
|
|
5.43
|
%
|
|
|
7.12
|
%
|
|
|
*11.58
|
%
|
4520
|
|
Technology Hardware & Equipment
|
|
|
3.41
|
%
|
|
|
2.32
|
%
|
|
|
5.73
|
%
|
|
|
3.74
|
%
|
|
|
3.95
|
%
|
|
|
7.69
|
%
|
4530
|
|
Semiconductor Equipment
|
|
|
3.94
|
%
|
|
|
1.90
|
%
|
|
|
5.83
|
%
|
|
|
5.42
|
%
|
|
|
4.74
|
%
|
|
|
*9.78
|
%
|
5010
|
|
Telecommunication Services
|
|
|
3.02
|
%
|
|
|
4.62
|
%
|
|
|
*6.50
|
%
|
|
|
7.23
|
%
|
|
|
13.28
|
%
|
|
|
*9.08
|
%
|
5510
|
|
Utilities
|
|
|
0.76
|
%
|
|
|
0.48
|
%
|
|
|
2.00
|
%
|
|
|
3.88
|
%
|
|
|
6.47
|
%
|
|
|
*5.64
|
%
|
*
|
The cap is generally the Mean + Standard Deviation, subject to minimum cap of 2% (de minimus allowance) and maximum +/-2 percentage points relative to prior year burn
rate cap for same industry/index group.
|
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|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-49
|
|
|
A premium (multiplier) is applied on full
value awards for the past three fiscal years. The guideline for applying the premium is as follows:
|
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Stock Price Volatility
|
|
Multiplier
|
54.6% and higher
|
|
1 full-value award will count as 1.5 option shares
|
36.1% or higher and less than 54.6%
|
|
1 full-value award will count as 2.0 option shares
|
24.9% or higher and less than 36.1%
|
|
1 full-value award will count as 2.5 option shares
|
16.5% or higher and less than 24.9%
|
|
1 full-value award will count as 3.0 option shares
|
7.9% or higher and less than 16.5%
|
|
1 full-value award will count as 3.5 option shares
|
Less than 7.9%
|
|
1 full-value award will count as 4.0 option shares
|
u
u
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u
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Liberal Definition of Change in Control
Generally vote AGAINST equity plans if the plan has a liberal definition of change in control (it provides for the acceleration of vesting of equity awards even though an actual change in control may not
occur) and the equity awards would automatically vest upon such liberal definition of change-in-control. Examples of such a definition include, but are not limited to, announcement or commencement of a tender offer, provisions for acceleration upon
a potential takeover, shareholder approval of a merger or other transactions, or similar language.
Problematic Pay Practices
If the equity plan on the ballot is a vehicle for
problematic pay practices
, vote AGAINST the plan.
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u
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Specific Treatment of Certain Award Types in Equity Plan Evaluations
Dividend Equivalent Rights
Options that have Dividend Equivalent Rights (DERs) associated with them will have a higher calculated award value than those without DERs under the binomial model, based on the value of these dividend
streams. The higher value will be applied to new shares, shares available under existing plans, and shares awarded but not exercised per the plan specifications. DERS transfer more shareholder equity to employees and non-employee directors and this
cost should be captured.
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Liberal Share Recycling Provisions
Under net share counting provisions, shares tendered by an option holder to pay for the exercise of an option, shares withheld for taxes or shares repurchased by the company on the open market can be
recycled back into the equity plan for awarding again. All awards with such provisions should be valued as full-value awards. Stock-settled stock appreciation rights (SSARs) will also be considered as full-value awards if a company counts only the
net shares issued to employees towards their plan reserve.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-50
|
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Operating Partnership (OP) Units in Equity Plan Analysis of Real Estate Investment Trusts (REITs)
For Real Estate Investment Trusts (REITS), include the common shares issuable upon conversion of outstanding Operating Partnership (OP) units in the share
count for the purposes of determining: (1) market capitalization in the Shareholder Value Transfer (SVT) analysis and (2) shares outstanding in the burn rate analysis.
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Option Overhang Cost
Companies with sustained positive stock performance and high overhang cost attributable to in-the-money options outstanding in excess of six years may warrant a carve-out of these options from the
overhang as long as the dilution attributable to the new share request is reasonable and the company exhibits sound compensation practices. Consider CASE-BY-CASE a carve-out of a portion of cost attributable to overhang, considering the following
criteria:
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Performance
: Companies with sustained positive stock performance will merit greater scrutiny. Five-year total shareholder return (TSR),
year-over-year performance, and peer performance could play a significant role in this determination.
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Overhang Disclosure
: Assess whether optionees have held in-the-money options for a prolonged period (thus reflecting their confidence in the
prospects of the company). Note that this assessment would require additional disclosure regarding a companys overhang. Specifically, the following disclosure would be required:
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|
The number of in-the-money options outstanding in excess of six or more years with a corresponding weighted average exercise price and weighted average
contractual remaining term;
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|
The number of all options outstanding less than six years and underwater options outstanding in excess of six years with a corresponding weighted
average exercise price and weighted average contractual remaining term;
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|
The general vesting provisions of option grants; and
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The distribution of outstanding option grants with respect to the named executive officers;
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Dilution
: Calculate the expected duration of the new share request in addition to all shares currently available for grant under the equity
compensation program, based on the companys three-year average burn rate (or a burn-rate commitment that the company makes for future years). The expected duration will be calculated by multiplying the companys unadjusted (options and
full-value awards accounted on a one-for-one basis) three-year average burn rate by the most recent fiscal years weighted average shares outstanding (as used in the companys calculation of basic EPS) and divide the sum of the new share
request and all available shares under the companys equity compensation program by the product. For example, an expected duration in excess of five years could be considered problematic; and
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Compensation Practices
: An evaluation of overall practices could include: (1) stock option repricing provisions, (2) high
concentration ratios (of grants to top executives), or (3) additional practices outlined in the Poor Pay Practices policy.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-51
|
|
|
Other
Compensation Plans
401(k) Employee Benefit Plans
Vote FOR proposals to implement a 401(k) savings plan for employees.
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u
Employee Stock Ownership Plans (ESOPs)
Vote FOR proposals to implement an ESOP or increase authorized shares for existing ESOPs, unless the number of shares allocated to the ESOP is excessive (more than five percent of outstanding shares).
u
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u
u
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Employee Stock Purchase PlansQualified Plans
Vote CASE-BY-CASE on qualified employee stock purchase plans. Vote FOR employee stock purchase plans where all of the following apply:
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Purchase price is at least 85 percent of fair market value;
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|
Offering period is 27 months or less; and
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|
The number of shares allocated to the plan is ten percent or less of the outstanding shares.
|
Vote AGAINST qualified employee stock purchase plans where any of the following apply:
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|
Purchase price is less than 85 percent of fair market value; or
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|
Offering period is greater than 27 months; or
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|
The number of shares allocated to the plan is more than ten percent of the outstanding shares.
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u
u
u
u
u
Employee Stock Purchase PlansNon-Qualified Plans
Vote CASE-BY-CASE on nonqualified employee stock purchase plans. Vote FOR nonqualified employee stock purchase plans with all the following features:
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Broad-based participation (
i.e.
, all employees of the company with the exclusion of individuals with 5 percent or more of beneficial ownership
of the company);
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Limits on employee contribution, which may be a fixed dollar amount or expressed as a percent of base salary;
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|
Company matching contribution up to 25 percent of employees contribution, which is effectively a discount of 20 percent from market value;
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|
No discount on the stock price on the date of purchase since there is a company matching contribution.
|
Vote AGAINST nonqualified employee stock purchase plans when any of the plan features do not meet the above criteria. If the company matching
contribution exceeds 25 percent of employees contribution, evaluate the cost of the plan against its allowable cap.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-52
|
|
|
Incentive Bonus Plans and Tax Deductibility Proposals (OBRA-Related Compensation Proposals)
Generally vote FOR proposals to approve or amend executive incentive bonus plans if the proposal:
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|
Is only to include administrative features;
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|
Places a cap on the annual grants any one participant may receive to comply with the provisions of Section 162(m);
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|
Adds performance goals to existing compensation plans to comply with the provisions of Section 162(m) unless they are clearly inappropriate; or
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Covers cash or cash and stock bonus plans that are submitted to shareholders for the purpose of exempting compensation from taxes under the provisions
of Section 162(m) if no increase in shares is requested.
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Vote AGAINST such proposals if:
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The compensation committee does not fully consist of independent outsiders, per ISS director classification; or
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|
The plan contains excessive problematic provisions.
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Vote CASE-BY CASE on such proposals if:
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In addition to seeking 162(m) tax treatment, the amendment may cause the transfer of additional shareholder value to employees (
e.g
., by
requesting additional shares, extending the option term, or expanding the pool of plan participants). Evaluate the Shareholder Value Transfer in comparison with the companys allowable cap; or
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A company is presenting the plan to shareholders for Section 162(m) favorable tax treatment for the first time after the companys initial
public offering (IPO). Perform a full equity plan analysis, including consideration of total shareholder value transfer, burn rate (if applicable), repricing, and liberal change in control. Other factors such as pay-for-performance or problematic
pay practices as related to Management Say-on-Pay may be considered if appropriate.
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u
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u
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Option Exchange Programs/Repricing Options
Vote CASE-BY-CASE on management proposals seeking approval to exchange/reprice options taking into consideration:
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|
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Historic trading patternsthe stock price should not be so volatile that the options are likely to be back in-the-money over the near
term;
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|
|
Rationale for the re-pricingwas the stock price decline beyond managements control?
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|
Is this a value-for-value exchange?
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|
|
|
Are surrendered stock options added back to the plan reserve?
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|
Option vestingdoes the new option vest immediately or is there a black-out period?
|
|
|
|
Term of the optionthe term should remain the same as that of the replaced option;
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|
|
|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-53
|
|
|
|
|
|
Exercise priceshould be set at fair market or a premium to market;
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|
|
|
Participantsexecutive officers and directors should be excluded.
|
If the surrendered options are added back to the equity plans for re-issuance, then also take into consideration the companys total cost of equity plans and its three-year average burn rate.
In addition to the above considerations, evaluate the intent, rationale, and timing of the repricing proposal. The proposal should clearly
articulate why the board is choosing to conduct an exchange program at this point in time. Repricing underwater options after a recent precipitous drop in the companys stock price demonstrates poor timing. Repricing after a recent decline in
stock price triggers additional scrutiny and a potential AGAINST vote on the proposal. At a minimum, the decline should not have happened within the past year. Also, consider the terms of the surrendered options, such as the grant date, exercise
price and vesting schedule. Grant dates of surrendered options should be far enough back (two to three years) so as not to suggest that repricings are being done to take advantage of short-term downward price movements. Similarly, the exercise price
of surrendered options should be above the 52-week high for the stock price.
Vote FOR shareholder proposals to put option repricings to a
shareholder vote.
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Stock Plans in Lieu of Cash
Vote CASE-BY-CASE on plans that provide participants with the option of taking all or a portion of their cash compensation in the form of stock.
Vote FOR non-employee director-only equity plans that provide a dollar-for-dollar cash-for-stock exchange.
Vote CASE-BY-CASE on plans which do not provide a dollar-for-dollar cash for stock exchange. In cases where the exchange is not dollar-for-dollar, the request for new or additional shares for such equity
program will be considered using the binomial option pricing model. In an effort to capture the total cost of total compensation, ISS will not make any adjustments to carve out the in-lieu-of cash compensation.
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Transfer Stock Option (TSO) Programs
One-time Transfers: Vote AGAINST or WITHHOLD from compensation committee members if they fail to submit one-time transfers to shareholders for approval.
Vote CASE-BY-CASE on one-time transfers. Vote FOR if:
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Executive officers and non-employee directors are excluded from participating;
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Stock options are purchased by third-party financial institutions at a discount to their fair value using option pricing models such as Black-Scholes
or a Binomial Option Valuation or other appropriate financial models;
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There is a two-year minimum holding period for sale proceeds (cash or stock) for all participants.
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Additionally, management should provide a clear explanation of why options are being transferred to a third-party institution and whether the events
leading up to a decline in stock price were beyond managements control. A review of the companys historic stock price volatility should indicate if the options are likely to be back in-the-money over the near term.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-54
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Ongoing TSO program: Vote AGAINST equity
plan proposals if the details of ongoing TSO programs are not provided to shareholders. Since TSOs will be one of the award types under a stock plan, the ongoing TSO program, structure and mechanics must be disclosed to shareholders. The specific
criteria to be considered in evaluating these proposals include, but not limited, to the following:
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Cost of the program and impact of the TSOs on companys total option expense
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Option repricing policy.
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Amendments to existing plans that allow for introduction of transferability of stock options should make clear that only options granted post-amendment
shall be transferable.
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Director Compensation
Equity Plans for Non-Employee Directors
Vote CASE-BY-CASE on
compensation plans for non-employee directors, based on the cost of the plans against the companys allowable cap.
On occasion, director
stock plans that set aside a relatively small number of shares when combined with employee or executive stock compensation plans will exceed the allowable cap. Vote for the plan if ALL of the following qualitative factors in the boards
compensation are met and disclosed in the proxy statement:
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Director stock ownership guidelines with a minimum of three times the annual cash retainer.
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Vesting schedule or mandatory holding/deferral period:
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A minimum vesting of three years for stock options or restricted stock; or
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Deferred stock payable at the end of a three-year deferral period.
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Mix between cash and equity:
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A balanced mix of cash and equity, for example 40% cash/60% equity or 50% cash/50% equity; or
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If the mix is heavier on the equity component, the vesting schedule or deferral period should be more stringent, with the lesser of five years or the
term of directorship.
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No retirement/benefits and perquisites provided to non-employee directors; and
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Detailed disclosure provided on cash and equity compensation delivered to each non-employee director for the most recent fiscal year in a table. The
column headers for the table may include the following: name of each non-employee director, annual retainer, board meeting fees, committee retainer, committee-meeting fees, and equity grants.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-55
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Non-Employee Director Retirement Plans
Vote AGAINST retirement plans for non-employee directors.
Vote FOR shareholder proposals to
eliminate retirement plans for non-employee directors.
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Shareholder Proposals on Compensation
Advisory Vote on Executive Compensation (Say-on-Pay)
Generally, vote FOR shareholder proposals that call for non-binding shareholder ratification of the compensation of the Named Executive Officers and the
accompanying narrative disclosure of material factors provided to understand the Summary Compensation Table.
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Adopt Anti-Hedging/Pledging/Speculative Investments Policy
Generally vote FOR proposals seeking a policy that prohibits named executive officers from engaging in derivative or speculative transactions involving company stock, including hedging, holding stock in a
margin account, or pledging stock as collateral for a loan. However, the companys existing policies regarding responsible use of company stock will be considered.
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Bonus Banking/Bonus Banking Plus
Vote CASE-BY-CASE on proposals seeking deferral of a portion of annual bonus pay, with ultimate payout linked to sustained results for the performance metrics on which the bonus was earned (whether for
the named executive officers or a wider group of employees), taking into account the following factors:
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The companys past practices regarding equity and cash compensation;
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Whether the company has a holding period or stock ownership requirements in place, such as a meaningful retention ratio (at least 50 percent for full
tenure); and
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Whether the company has a rigorous claw-back policy in place.
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Compensation ConsultantsDisclosure of Board or Companys Utilization
Generally vote FOR shareholder proposals seeking disclosure regarding the Company, Board, or Compensation Committees use of compensation
consultants, such as company name, business relationship(s) and fees paid.
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Disclosure/Setting Levels or Types of Compensation for
Executives and Directors
Generally, vote FOR shareholder proposals seeking additional disclosure of executive and director pay
information, provided the information requested is relevant to shareholders needs, would not put the company at a competitive disadvantage relative to its industry, and is not unduly burdensome to the company.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-56
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Vote AGAINST shareholder proposals seeking
to set absolute levels on compensation or otherwise dictate the amount or form of compensation.
Vote AGAINST shareholder proposals seeking to
eliminate stock options or any other equity grants to employees or directors.
Vote AGAINST shareholder proposals requiring director fees be
paid in stock only.
Generally vote AGAINST shareholder proposals that mandate a minimum amount of stock that directors must own in order to
qualify as a director or to remain on the board.
Vote CASE-BY-CASE on all other shareholder proposals regarding executive and director pay,
taking into account company performance, pay level versus peers, pay level versus industry, and long-term corporate outlook.
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Golden Coffins/Executive Death Benefits
Generally vote FOR proposals calling companies to adopt a policy of obtaining shareholder approval for any future agreements and corporate policies that could oblige the company to make payments or awards
following the death of a senior executive in the form of unearned salary or bonuses, accelerated vesting or the continuation in force of unvested equity grants, perquisites and other payments or awards made in lieu of compensation. This would not
apply to any benefit programs or equity plan proposals that the broad-based employee population is eligible.
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Hold Equity Past Retirement or for a Significant Period of Time
Vote CASE-BY-CASE on shareholder proposals asking companies to adopt policies requiring senior executive officers to retain all or a significant portion
of the shares acquired through compensation plans, either:
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while employed and/or for two years following the termination of their employment ; or
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for a substantial period following the lapse of all other vesting requirements for the award (lock-up period), with ratable release of a
portion of the shares annually during the lock-up period.
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The following factors will be taken into account:
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Whether the company has any holding period, retention ratio, or officer ownership requirements in place. These should consist of:
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Rigorous stock ownership guidelines;
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A holding period requirement coupled with a significant long-term ownership requirement; or
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A meaningful retention ratio;
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Actual officer stock ownership and the degree to which it meets or exceeds the proponents suggested holding period/retention ratio or the
companys own stock ownership or retention requirements;
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-57
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Post-termination holding requirement policies or any policies aimed at mitigating risk taking by senior executives;
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Problematic pay practices, current and past, which may promote a short-term versus a long-term focus.
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A rigorous stock ownership guideline should be at least 10x base salary for the CEO, with the multiple declining for other executives. A meaningful
retention ratio should constitute at least 50 percent of the stock received from equity awards (on a net proceeds basis) held on a long-term basis, such as the executives tenure with the company or even a few years past the executives
termination with the company.
Vote CASE-BY-CASE on shareholder proposals asking companies to adopt policies requiring Named Executive
Officers to retain 75% of the shares acquired through compensation plans while employed and/or for two years following the termination of their employment, and to report to shareholders regarding this policy. The following factors will be taken into
account:
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Whether the company has any holding period, retention ratio, or officer ownership requirements in place. These should consist of:
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Rigorous stock ownership guidelines, or
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A holding period requirement coupled with a significant long-term ownership requirement, or
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A meaningful retention ratio,
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Actual officer stock ownership and the degree to which it meets or exceeds the proponents suggested holding period/retention ratio or the
companys own stock ownership or retention requirements.
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Problematic pay practices, current and past, which may promote a short-term versus a long-term focus.
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A rigorous stock ownership guideline should be at least 10x base salary for the CEO, with the multiple declining for other executives. A meaningful
retention ratio should constitute at least 50 percent of the stock received from equity awards (on a net proceeds basis) held on a long-term basis, such as the executives tenure with the company or even a few years past the executives
termination with the company.
Generally vote AGAINST shareholder proposals that mandate a minimum amount of stock that directors must own in
order to qualify as a director or to remain on the board. While ISS favors stock ownership on the part of directors, the company should determine the appropriate ownership requirement.
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Non-Deductible Compensation
Generally vote FOR proposals seeking disclosure of the extent to which the company paid non-deductible compensation to senior executives due to Internal Revenue Code Section 162(m), while considering
the companys existing disclosure practices.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-58
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Pay for
Performance
Performance-Based Awards
Vote CASE-BY-CASE on shareholder proposal requesting that a significant amount of future long-term incentive compensation awarded to senior executives shall be performance-based and requesting that the
board adopt and disclose challenging performance metrics to shareholders, based on the following analytical steps:
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First, vote FOR shareholder proposals advocating the use of performance-based equity awards, such as performance contingent options or restricted
stock, indexed options or premium-priced options, unless the proposal is overly restrictive or if the company has demonstrated that it is using a substantial portion of performance-based awards for its top executives. Standard stock
options and performance-accelerated awards do not meet the criteria to be considered as performance-based awards. Further, premium-priced options should have a premium of at least 25 percent and higher to be considered performance-based awards.
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Second, assess the rigor of the companys performance-based equity program. If the bar set for the performance-based program is too low based on
the companys historical or peer group comparison, generally vote FOR the proposal. Furthermore, if target performance results in an above target payout, vote FOR the shareholder proposal due to programs poor design. If the company does
not disclose the performance metric of the performance-based equity program, vote FOR the shareholder proposal regardless of the outcome of the first step to the test.
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In general, vote FOR the shareholder proposal if the company does not meet both of the above two steps.
Pay for Superior Performance
Vote CASE-BY-CASE on
shareholder proposals that request the board establish a pay-for-superior performance standard in the companys executive compensation plan for senior executives. These proposals generally include the following principles:
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Set compensation targets for the plans annual and long-term incentive pay components at or below the peer group median;
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Deliver a majority of the plans target long-term compensation through performance-vested, not simply time-vested, equity awards;
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Provide the strategic rationale and relative weightings of the financial and non-financial performance metrics or criteria used in the annual and
performance-vested long-term incentive components of the plan;
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Establish performance targets for each plan financial metric relative to the performance of the companys peer companies;
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Limit payment under the annual and performance-vested long-term incentive components of the plan to when the companys performance on its selected
financial performance metrics exceeds peer group median performance.
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Consider the following factors in evaluating this
proposal:
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What aspects of the companys annual and long-term equity incentive programs are performance driven?
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If the annual and long-term equity incentive programs are performance driven, are the performance criteria and hurdle rates disclosed to shareholders
or are they benchmarked against a disclosed peer group?
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-59
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Can shareholders assess the correlation between pay and performance based on the current disclosure?
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What type of industry and stage of business cycle does the company belong to?
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Pre-Arranged Trading Plans (10b5-1 Plans)
Generally vote FOR shareholder proposals calling for certain principles regarding the use of prearranged trading plans (10b5-1 plans) for executives. These principles include:
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Adoption, amendment, or termination of a 10b5-1 Plan must be disclosed within two business days in a Form 8-K;
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Amendment or early termination of a 10b5-1 Plan is allowed only under extraordinary circumstances, as determined by the board;
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Ninety days must elapse between adoption or amendment of a 10b5-1 Plan and initial trading under the plan;
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Reports on Form 4 must identify transactions made pursuant to a 10b5-1 Plan;
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An executive may not trade in company stock outside the 10b5-1 Plan.
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Trades under a 10b5-1 Plan must be handled by a broker who does not handle other securities transactions for the executive.
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Prohibit CEOs from Serving on Compensation Committees
Generally vote AGAINST proposals seeking a policy to prohibit any outside CEO from serving on a companys compensation committee, unless the company
has demonstrated problematic pay practices that raise concerns about the performance and composition of the committee.
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Recoup Bonuses (Clawbacks)
Vote CASE-BY-CASE on proposals to recoup unearned incentive bonuses or other incentive payments made to senior executives if it is later determined that the figures upon which incentive compensation is
earned later turn out to have been in error. This is line with the clawback provision in the Trouble Asset Relief Program. Many companies have adopted policies that permit recoupment in cases where fraud, misconduct, or negligence significantly
contributed to a restatement of financial results that led to the awarding of unearned incentive compensation. ISS will take into consideration:
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If the company has adopted a formal recoupment bonus policy;
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If the company has chronic restatement history or material financial problems; or
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If the companys policy substantially addresses the concerns raised by the proponent.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-60
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Severance
Agreements for Executives/Golden Parachutes
Vote FOR shareholder proposals requiring that golden parachutes or executive severance
agreements be submitted for shareholder ratification, unless the proposal requires shareholder approval
prior
to entering into employment contracts.
Vote CASE-BY-CASE on proposals to ratify or cancel golden parachutes. An acceptable parachute should include, but is not limited to, the following:
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The triggering mechanism should be beyond the control of management;
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The amount should not exceed three times base amount (defined as the average annual taxable W-2 compensation during the five years prior to the year in
which the change of control occurs);
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Change-in-control payments should be double-triggered,
i.e.
, (1) after a change in control has taken place, and (2) termination of the
executive as a result of the change in control. Change in control is defined as a change in the company ownership structure.
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Share Buyback Holding Periods
Generally vote AGAINST shareholder proposals prohibiting executives from selling shares of company stock during periods in which the company has announced that it may or will be repurchasing shares of its
stock. Vote FOR the proposal when there is a pattern of abuse by executives exercising options or selling shares during periods of share buybacks.
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Supplemental Executive Retirement Plans (SERPs)
Generally vote FOR shareholder proposals requesting to put extraordinary benefits contained in SERP agreements to a shareholder vote unless the companys executive pension plans do not contain
excessive benefits beyond what is offered under employee-wide plans.
Generally vote FOR shareholder proposals requesting to limit the
executive benefits provided under the companys supplemental executive retirement plan (SERP) by limiting covered compensation to a senior executives annual salary and excluding of all incentive or bonus pay from the plans
definition of covered compensation used to establish such benefits.
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Tax Gross-Up Proposals
Generally vote FOR proposals calling for companies to adopt a policy of not providing tax gross-up payments to executives, except in situations where
gross-ups are provided pursuant to a plan, policy, or arrangement applicable to management employees of the company, such as a relocation or expatriate tax equalization policy.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-61
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Termination of Employment Prior to Severance Payment/Eliminating Accelerated Vesting of Unvested Equity
Vote CASE-BY-CASE on shareholder proposals seeking a policy requiring termination of employment prior to severance payment and/or eliminating accelerated
vesting of unvested equity.
The following factors will be considered:
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The companys current treatment of equity in change-of-control situations (
i.e.
is it double triggered, does it allow for the assumption of
equity by acquiring company, the treatment of performance shares, etc.);
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Current employment agreements, including potential poor pay practices such as gross-ups embedded in those agreements.
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Generally vote FOR proposals seeking a policy that prohibits acceleration of the vesting of equity awards to senior executives in the event of a change
in control (except for pro rata vesting considering the time elapsed and attainment of any related performance goals between the award date and the change in control).
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6. Social/Environmental Issues
Overall Approach
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When evaluating social and environmental shareholder proposals, ISS considers the following factors:
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Whether adoption of the proposal is likely to enhance or protect shareholder value;
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Whether the information requested concerns business issues that relate to a meaningful percentage of the companys business as measured by sales,
assets, and earnings;
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The degree to which the companys stated position on the issues raised in the proposal could affect its reputation or sales, or leave it
vulnerable to a boycott or selective purchasing;
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Whether the issues presented are more appropriately/effectively dealt with through governmental or company-specific action;
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Whether the company has already responded in some appropriate manner to the request embodied in the proposal;
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Whether the companys analysis and voting recommendation to shareholders are persuasive;
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What other companies have done in response to the issue addressed in the proposal;
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Whether the proposal itself is well framed and the cost of preparing the report is reasonable;
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Whether implementation of the proposals request would achieve the proposals objectives;
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Whether the subject of the proposal is best left to the discretion of the board;
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Whether the requested information is available to shareholders either from the company or from a publicly available source; and
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Whether providing this information would reveal proprietary or confidential information that would place the company at a competitive disadvantage.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-62
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Animal
Welfare
Animal Welfare Policies
Generally vote FOR proposals seeking a report on the companys animal welfare standards unless:
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The company has already published a set of animal welfare standards and monitors compliance;
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The companys standards are comparable to industry peers; and
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There are no recent, significant fines or litigation related to the companys treatment of animals.
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Animal Testing
Generally vote AGAINST proposals to phase out the use of animals in product testing unless:
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The company is conducting animal testing programs that are unnecessary or not required by regulation;
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The company is conducting animal testing when suitable alternatives are commonly accepted and used at industry peers; or
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There are recent, significant fines or litigation related to the companys treatment of animals.
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Animal Slaughter (Controlled Atmosphere Killing (CAK))
Generally vote AGAINST proposals requesting the implementation of CAK methods at company and/or supplier operations unless such methods are required by legislation or generally accepted as the industry
standard.
Vote CASE-BY-CASE on proposals requesting a report on the feasibility of implementing CAK methods at company and/or supplier
operations considering the availability of existing research conducted by the company or industry groups on this topic and any fines or litigation related to current animal processing procedures at the company.
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Consumer Issues
Genetically Modified Ingredients
Generally vote AGAINST
proposals asking suppliers, genetic research companies, restaurants and food retail companies to voluntarily label genetically engineered (GE) ingredients in their products and/or eliminate GE ingredients. The cost of labeling and/or phasing out the
use of GE ingredients may not be commensurate with the benefits to shareholders and is an issue better left to regulators.
Vote CASE-BY-CASE
on proposals asking for a report on the feasibility of labeling products containing GE ingredients taking into account:
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The companys business and the proportion of it affected by the resolution;
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The quality of the companys disclosure on GE product labeling, related voluntary initiatives, and how this disclosure compares with industry peer
disclosure; and
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Companys current disclosure on the feasibility of GE product labeling, including information on the related costs.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-63
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Generally vote AGAINST proposals seeking a
report on the social, health, and environmental effects of genetically modified organisms (GMOs). Studies of this sort are better undertaken by regulators and the scientific community.
Generally vote AGAINST proposals to completely phase out GE ingredients from the companys products or proposals asking for reports outlining the steps necessary to eliminate GE ingredients from the
companys products. Such resolutions presuppose that there are proven health risks to GE ingredients (an issue better left to regulators) that may outweigh the economic benefits derived from biotechnology.
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Reports on Potentially Controversial Business/Financial Practices
Vote CASE-BY CASE on requests for reports on the companys potentially controversial business or financial practices or products taking into account:
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Whether the company has adequately disclosed mechanisms in place to prevent abuses;
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Whether the company has adequately disclosed the financial risks of the products/practices in question;
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Whether the company has been subject to violations of related laws or serious controversies; and
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Peer companies policies/practices in this area.
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Pharmaceutical Pricing, Access to Medicines, Product Reimportation, and Health Pandemics
Generally vote AGAINST proposals requesting that companies implement specific price restraints on pharmaceutical products unless the company fails to
adhere to legislative guidelines or industry norms in its product pricing.
Vote CASE-BY-CASE on proposals requesting that the company
evaluate report on their product pricing policies or their access to medicine policies, considering:
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The nature of the companys business and the potential for reputational and market risk exposure;
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The existing disclosure of relevant policies;
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Deviation from established industry norms;
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The companys existing, relevant initiatives to provide research and/or products to disadvantaged consumers;
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Whether the proposal focuses on specific products or geographic regions; and
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The potential cost and scope of the requested report.
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Generally vote FOR proposals requesting that companies report on the financial and legal impact of their prescription drug reimportation policies unless such information is already publicly disclosed.
Generally vote AGAINST proposals requesting that companies adopt specific policies to encourage or constrain prescription drug reimportation.
Such matters are more appropriately the province of legislative activity and may place the company at a competitive disadvantage relative to its peers.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-64
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Health Pandemics
Vote CASE-BY-CASE on requests for reports outlining the impact of health pandemics (such as HIV/AIDS, malaria, tuberculosis, and avian flu) on the
companys operations and how the company is responding to the situation, taking into account:
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The scope of the companys operations in the affected/relevant area(s);
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The companys existing healthcare policies, including benefits and healthcare access; and
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Company donations to relevant healthcare providers.
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Vote AGAINST proposals asking companies to establish, implement, and report on a standard of response to health pandemics (such as HIV/AIDS, malaria, tuberculosis, and avian flu), unless the company has
significant operations in the affected markets and has failed to adopt policies and/or procedures to address these issues comparable to those of industry peers.
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Product Safety and Toxic/Hazardous Materials
Generally vote FOR proposals requesting the company to report on its policies, initiatives/procedures, and oversight mechanisms related to toxic/hazardous materials or product safety in its supply chain,
unless:
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The company already discloses similar information through existing reports such as a Supplier Code of Conduct and/or a sustainability report;
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The company has formally committed to the implementation of a toxic/hazardous materials and/or product safety and supply chain reporting and monitoring
program based on industry norms or similar standards within a specified time frame; and
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The company has not been recently involved in relevant significant controversies, significant fines, or litigation.
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Vote CASE-BY-CASE on resolutions requesting that companies develop a feasibility assessment to phase-out of certain toxic/hazardous materials, or
evaluate and disclose the potential financial and legal risks associated with utilizing certain materials, considering:
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The companys current level of disclosure regarding its product safety policies, initiatives and oversight mechanisms.
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Current regulations in the markets in which the company operates; and
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Recent significant controversies, litigation, or fines stemming from toxic/hazardous materials at the company.
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Generally vote AGAINST resolutions requiring that a company reformulate its products.
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Tobacco-Related Proposals
Vote CASE-BY-CASE on resolutions regarding the advertisement of tobacco products, considering:
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Recent related fines, controversies, or significant litigation;
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Whether the company complies with relevant laws and regulations on the marketing of tobacco;
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ISS 2012 U.S. Proxy Voting Summary Guidelines
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B-65
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Whether the companys advertising restrictions deviate from those of industry peers;
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Whether the company entered into the Master Settlement Agreement, which restricts marketing of tobacco to youth;
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Whether restrictions on marketing to youth extend to foreign countries.
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Vote CASE-BY-CASE on proposals regarding second-hand smoke, considering;
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Whether the company complies with all laws and regulations;
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The degree that voluntary restrictions beyond those mandated by law might hurt the companys competitiveness;
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The risk of any health-related liabilities.
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Generally vote AGAINST resolutions to cease production of tobacco-related products, to avoid selling products to tobacco companies, to spin-off tobacco-related businesses, or prohibit investment in
tobacco equities. Such business decisions are better left to company management or portfolio managers.
Generally vote AGAINST proposals
regarding tobacco product warnings. Such decisions are better left to public health authorities.
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Climate Change and the Environment
Climate Change/Greenhouse Gas (GHG) Emissions
Generally vote FOR resolutions requesting that a company disclose information on the impact of climate change on the companys operations and investments considering:
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The company already provides current, publicly-available information on the impacts that climate change may have on the company as well as associated
company policies and procedures to address related risks and/or opportunities;
|
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The companys level of disclosure is at least comparable to that of industry peers; and
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There are no significant, controversies, fines, penalties, or litigation associated with the companys environmental performance.
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Generally vote FOR proposals requesting a report on greenhouse gas (GHG) emissions from company operations and/or products
and operations, unless:
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The company already provides current, publicly-available information on the impacts that GHG emissions may have on the company as well as associated
company policies and procedures to address related risks and/or opportunities;
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The companys level of disclosure is comparable to that of industry peers; and
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There are no significant, controversies, fines, penalties, or litigation associated with the companys GHG emissions.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
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B-66
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Vote CASE-BY-CASE on proposals that call
for the adoption of GHG reduction goals from products and operations, taking into account:
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Overly prescriptive requests for the reduction in GHG emissions by specific amounts or within a specific time frame;
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Whether company disclosure lags behind industry peers;
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Whether the company has been the subject of recent, significant violations, fines, litigation, or controversy related to GHG emissions;
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The feasibility of reduction of GHGs given the companys product line and current technology and;
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Whether the company already provides meaningful disclosure on GHG emissions from its products and operations.
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General Environmental Proposals and Community Impact Assessments, Concentrated Area Feeding Operations
General Environmental Proposals and Community Impact Assessments
Vote CASE-BY-CASE on requests for reports outlining policies and/or the potential (community) social and/or environmental impact of company operations considering:
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Current disclosure of applicable policies and risk assessment report(s) and risk management procedures;
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The impact of regulatory non-compliance, litigation, remediation, or reputational loss that may be associated with failure to manage the companys
operations in question, including the management of relevant community and stakeholder relations;
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The nature, purpose, and scope of the companys operations in the specific region(s);
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The degree to which company policies and procedures are consistent with industry norms; and
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The scope of the resolution.
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Concentrated Area Feeding Operations (CAFOs)
Generally vote FOR resolutions
requesting companies report to shareholders on the risks and liabilities associated with CAFOs unless:
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The company has publicly disclosed its environmental management policies for its corporate and contract farming operations, including compliance
monitoring; and
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The company publicly discloses company and supplier farm environmental performance data; or
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The company does not have company-owned CAFOs and does not directly source from contract farm CAFOs.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
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B-67
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Energy
Efficiency
Generally vote FOR on proposals requesting a company report on its comprehensive energy efficiency policies, unless:
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The company complies with applicable energy efficiency regulations and laws, and discloses its participation in energy efficiency policies and
programs, including disclosure of benchmark data, targets, and performance measures; or
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The proponent requests adoption of specific energy efficiency goals within specific timelines.
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Facility and Operational Safety/Security
Vote CASE-BY-CASE on resolutions requesting that companies report on safety and/or security risks associated with their operations and/or facilities, considering:
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The companys compliance with applicable regulations and guidelines;
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The companys current level of disclosure regarding its security and safety policies, procedures, and compliance monitoring; and,
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The existence of recent, significant violations, fines, or controversy regarding the safety and security of the companys operations and/or
facilities.
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Hydraulic Fracturing
Generally vote FOR proposals requesting greater disclosure of a companys (natural gas) hydraulic fracturing operations, including measures the company has taken to manage and mitigate the potential
community and environmental impacts of those operations, considering:
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The companys current level of disclosure of relevant policies and oversight mechanisms;
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The companys current level of such disclosure relative to its industry peers;
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Potential relevant local, state, or national regulatory developments; and
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Controversies, fines, or litigation related to the companys hydraulic fracturing operations.
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Operations in Protected Areas
Generally vote FOR requests for reports on potential environmental damage as a result of company operations in protected regions unless:
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Operations in the specified regions are not permitted by current laws or regulations;
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The company does not currently have operations or plans to develop operations in these protected regions; or,
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The companys disclosure of its operations and environmental policies in these regions is comparable to industry peers.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
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B-68
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Recycling
Vote CASE-BY-CASE on proposals to report on an existing recycling program, or adopt a new recycling program, taking into account:
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The nature of the companys business;
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The current level of disclosure of the companys existing related programs;
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The timetable prescribed by the proposal and the costs and methods of program implementation;
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The ability of the company to address the issues raised in the proposal; and
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The companys recycling programs compared with the similar programs of its industry peers.
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Renewable Energy
Generally vote FOR requests for reports on the feasibility of developing renewable energy resources unless the report is duplicative of existing disclosure or irrelevant to the companys line of
business.
Generally vote AGAINST proposals requesting that the company invest in renewable energy resources. Such decisions are best left to
managements evaluation of the feasibility and financial impact that such programs may have on the company.
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Diversity
Board Diversity
Generally vote FOR requests for reports on the companys efforts to diversify the board, unless:
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The gender and racial minority representation of the companys board is reasonably inclusive in relation to companies of similar size and
business; and
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The board already reports on its nominating procedures and gender and racial minority initiatives on the board and within the company.
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Vote CASE-BY-CASE on proposals asking the company to increase the gender and racial minority representation on its board,
taking into account:
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The degree of existing gender and racial minority diversity on the companys board and among its executive officers;
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The level of gender and racial minority representation that exists at the companys industry peers;
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The companys established process for addressing gender and racial minority board representation;
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Whether the proposal includes an overly prescriptive request to amend nominating committee charter language;
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The independence of the companys nominating committee;
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The company uses an outside search firm to identify potential director nominees; and
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Whether the company has had recent controversies, fines, or litigation regarding equal employment practices.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-69
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Equality
of Opportunity
Generally vote FOR proposals requesting a company disclose its diversity policies or initiatives, or proposals requesting
disclosure of a companys comprehensive workforce diversity data, including requests for EEO-1 data, unless:
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The company publicly discloses its comprehensive equal opportunity policies and initiatives;
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The company already publicly discloses comprehensive workforce diversity data; and
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The company has no recent significant EEO-related violations or litigation.
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Generally vote AGAINST proposals seeking information on the diversity efforts of suppliers and service providers. Such requests may pose a significant cost and administration burden on the company.
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Gender Identity, Sexual Orientation, and Domestic Partner Benefits
Generally vote FOR proposals seeking to amend a companys EEO statement or diversity policies to prohibit discrimination based on sexual orientation
and/or gender identity, unless the change would result in excessive costs for the company.
Generally vote AGAINST proposals to extend company
benefits to, or eliminate benefits from domestic partners. Decisions regarding benefits should be left to the discretion of the company.
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General Corporate Issues
Charitable Contributions
Vote AGAINST proposals restricting
the company from making charitable contributions. Charitable contributions are generally useful for assisting worthwhile causes and for creating goodwill in the community. In the absence of bad faith, self-dealing, or gross negligence, management
should determine which, and if, contributions are in the best interests of the company.
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Environmental, Social, and Governance (ESG)
Compensation-Related Proposals
Generally vote AGAINST proposals to link, or report on linking, executive compensation to environmental and
social criteria such as corporate downsizings, customer or employee satisfaction, community involvement, human rights, environmental performance, or predatory lending. However, the following factors will be considered:
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Whether the company has significant and persistent controversies or violations regarding social and/or environmental issues;
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Whether the company has management systems and oversight mechanisms in place regarding its social and environmental performance;
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The degree to which industry peers have incorporated similar non-financial performance criteria in their executive compensation practices; and
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The companys current level of disclosure regarding its environmental and social performance.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-70
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Generally vote AGAINST proposals calling
for an analysis of the pay disparity between corporate executives and other non-executive employees. The value of the information sought by such proposals is unclear.
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Political Spending & Lobbying Activities
Generally vote AGAINST proposals asking the company to affirm political nonpartisanship in the workplace so long as:
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There are no recent, significant controversies, fines or litigation regarding the companys political contributions or trade association spending;
and
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The company has procedures in place to ensure that employee contributions to company-sponsored political action committees (PACs) are strictly
voluntary and prohibit coercion.
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Vote AGAINST proposals to publish in newspapers and other media the companys
political contributions. Such publications could present significant cost to the company without providing commensurate value to shareholders.
Generally vote FOR proposals requesting greater disclosure of a companys political contributions and trade association spending policies and
activities. However, the following will be considered:
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The companys current disclosure of policies and oversight mechanisms related to its direct political contributions and payments to trade
associations or other groups that may be used for political purposes, including information on the types of organizations supported and the business rationale for supporting these organizations; and
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Recent significant controversies, fines, or litigation related to the companys political contributions or political activities.
|
Vote AGAINST proposals barring the company from making political contributions. Businesses are affected by legislation at
the federal, state, and local level; barring political contributions can put the company at a competitive disadvantage.
Vote AGAINST
proposals asking for a list of company executives, directors, consultants, legal counsels, lobbyists, or investment bankers that have prior government service and whether such service had a bearing on the business of the company. Such a list would
be burdensome to prepare without providing any meaningful information to shareholders.
Vote CASE-BY-CASE on proposals requesting information
on a companys lobbying activities, including direct lobbying as well as grassroots lobbying activities, considering:
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The companys current disclosure of relevant policies and oversight mechanisms;
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Recent significant controversies, fines, or litigation related to the companys public policy activities; and
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The impact that the policy issues may have on the companys business operations.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-71
|
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International Issues, Labor Issues, and Human Rights
International Human Rights Proposals
Generally vote FOR
proposals requesting a report on company or company supplier labor and/or human rights standards and policies unless such information is already publicly disclosed.
Vote CASE-BY-CASE on proposals to implement company or company supplier labor and/or human rights standards and policies, considering:
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The degree to which existing relevant policies and practices are disclosed;
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Whether or not existing relevant policies are consistent with internationally recognized standards;
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Whether company facilities and those of its suppliers are monitored and how;
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Company participation in fair labor organizations or other internationally recognized human rights initiatives;
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Scope and nature of business conducted in markets known to have higher risk of workplace labor/human rights abuse;
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Recent, significant company controversies, fines, or litigation regarding human rights at the company or its suppliers;
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The scope of the request; and
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Deviation from industry sector peer company standards and practices.
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Internet Privacy and Censorship
Vote CASE-BY-CASE on resolutions requesting the disclosure and implementation of Internet privacy and censorship policies and procedures considering:
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The level of disclosure of company policies and procedures relating to privacy, freedom of speech, Internet censorship, and government monitoring of
the Internet;
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Engagement in dialogue with governments and/or relevant groups with respect to the Internet and the free flow of information;
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The scope of business involvement and of investment in markets that maintain government censorship or monitoring of the Internet;
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The market-specific laws or regulations applicable to Internet censorship or monitoring that may be imposed on the company; and,
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The level of controversy or litigation related to the companys international human rights policies and procedures.
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MacBride Principles
Generally vote AGAINST proposals to endorse or increase activity on the MacBride Principles, unless:
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The company has formally been found to be out of compliance with relevant Northern Ireland fair employment laws and regulations;
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-72
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Failure to implement the MacBride Principles would put the company in an inconsistent position and/or at a competitive disadvantage compared with
industry peers;
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Failure to implement the MacBride Principles would subject the company to excessively negative financial impacts due to laws that some municipalities
have passed regarding their contracting operations and companies that have not implemented the MacBride Principles; or
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The company has had recent, significant controversies, fines or litigation regarding religious-based employment discrimination in Northern Ireland.
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Operations in High Risk Markets
Vote CASE-BY-CASE on requests for a report on a companys potential financial and reputational risks associated with operations in high-risk markets, such as a terrorism-sponsoring state
or politically/socially unstable region, taking into account:
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The nature, purpose, and scope of the operations and business involved that could be affected by social or political disruption;
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Current disclosure of applicable risk assessment(s) and risk management procedures;
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Compliance with U.S. sanctions and laws;
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Consideration of other international policies, standards, and laws; and
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Whether the company has been recently involved in recent, significant controversies, fines or litigation related to its operations in
high-risk markets.
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Outsourcing/Offshoring
Vote CASE-BY-CASE on proposals calling for companies to report on the risks associated with outsourcing/plant closures, considering:
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Controversies surrounding operations in the relevant market(s);
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The value of the requested report to shareholders;
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The companys current level of disclosure of relevant information on outsourcing and plant closure procedures; and
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The companys existing human rights standards relative to industry peers.
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Workplace Safety
Vote CASE-BY CASE on requests for workplace safety reports, including reports on accident risk reduction efforts, taking into account:
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The current level of company disclosure of its workplace health and safety performance data, health and safety management policies, initiatives, and
oversight mechanisms;
|
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The nature of the companys business, specifically regarding company and employee exposure to health and safety risks;
|
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|
|
|
ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-73
|
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Recent significant controversies, fines, or violations related to workplace health and safety; and
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The companys workplace health and safety performance relative to industry peers.
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Weapons and Military Sales
Foreign Military Sales/Offsets
Vote AGAINST reports on foreign military sales or offsets.
Such disclosures may involve sensitive and confidential information. Moreover, companies must comply with government controls and reporting on foreign military sales.
Nuclear and Depleted Uranium Weapons
Generally vote AGAINST proposals asking a company to
cease production or report on the risks associated with the use of depleted uranium munitions or nuclear weapons components and delivery systems, including disengaging from current and proposed contracts. Such contracts are monitored by government
agencies, serve multiple military and non-military uses, and withdrawal from these contracts could have a negative impact on the companys business.
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Sustainability
Sustainability Reporting
Generally vote FOR proposals
requesting the company to report on its policies, initiatives, and oversight mechanisms related to social, economic, and environmental sustainability, unless:
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The company already discloses similar information through existing reports or policies such as an Environment, Health, and Safety (EHS) report; a
comprehensive Code of Corporate Conduct; and/or a Diversity Report; or
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The company has formally committed to the implementation of a reporting program based on Global Reporting Initiative (GRI) guidelines or a similar
standard within a specified time frame.
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Water Issues
Vote CASE-BY-CASE on proposals requesting a company report on, or to adopt a new policy on, water-related risks and concerns, taking into account:
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The companys current disclosure of relevant policies, initiatives, oversight mechanisms, and water usage metrics;
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Whether or not the companys existing water-related policies and practices are consistent with relevant internationally recognized standards and
national/local regulations;
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The potential financial impact or risk to the company associated with water-related concerns or issues; and
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Recent, significant company controversies, fines, or litigation regarding water use by the company and its suppliers.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-74
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7. Mutual
Fund Proxies
Election of Directors
Vote CASE-BY-CASE on the election of directors and trustees, following the same guidelines for uncontested directors for public company shareholder meetings. However, mutual fund boards do not usually
have compensation committees, so do not withhold for the lack of this committee.
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Converting Closed-end Fund to Open-end Fund
Vote CASE-BY-CASE on conversion proposals, considering the following factors:
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Past performance as a closed-end fund;
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Market in which the fund invests;
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Measures taken by the board to address the discount; and
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Past shareholder activism, board activity, and votes on related proposals.
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Proxy Contests
Vote CASE-BY-CASE on proxy contests, considering the following factors:
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Past performance relative to its peers;
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Market in which fund invests;
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Measures taken by the board to address the issues;
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Past shareholder activism, board activity, and votes on related proposals;
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Strategy of the incumbents versus the dissidents;
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Independence of directors;
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Experience and skills of director candidates;
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Governance profile of the company;
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Evidence of management entrenchment.
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Investment Advisory Agreements
Vote CASE-BY-CASE on investment advisory agreements, considering the following factors:
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Proposed and current fee schedules;
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Fund category/investment objective;
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Performance benchmarks;
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Share price performance as compared with peers;
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-75
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Resulting fees relative to peers;
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Assignments (where the advisor undergoes a change of control).
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Approving New Classes or Series of Shares
Vote FOR the establishment of new classes or series of shares.
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Preferred Stock Proposals
Vote CASE-BY-CASE on the authorization for or increase in preferred shares, considering the following factors:
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Stated specific financing purpose;
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Possible dilution for common shares;
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Whether the shares can be used for antitakeover purposes.
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1940 Act Policies
Vote CASE-BY-CASE on policies under the Investment Advisor Act of 1940, considering the following factors:
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Potential competitiveness;
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Regulatory developments;
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Current and potential returns; and
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Current and potential risk.
|
Generally vote FOR these amendments as long as the proposed changes do not fundamentally alter the investment focus of the fund and do comply with the
current SEC interpretation.
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Changing a Fundamental Restriction to a Nonfundamental Restriction
Vote CASE-BY-CASE on proposals to change a fundamental restriction to a non-fundamental restriction, considering the following factors:
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The funds target investments;
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The reasons given by the fund for the change; and
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The projected impact of the change on the portfolio.
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Change Fundamental Investment Objective to Nonfundamental
Vote AGAINST proposals to change a funds fundamental investment objective to non-fundamental.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-76
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Name
Change Proposals
Vote CASE-BY-CASE on name change proposals, considering the following factors:
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|
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Political/economic changes in the target market;
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Consolidation in the target market; and
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Current asset composition.
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Change in Funds Subclassification
Vote CASE-BY-CASE on changes in a funds sub-classification, considering the following factors:
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|
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Potential competitiveness;
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Current and potential returns;
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Consolidation in target industry.
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Business Development CompaniesAuthorization to Sell Shares of Common Stock at a Price below Net Asset Value
Vote FOR proposals authorizing the board to issue shares below Net Asset Value (NAV) if:
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The proposal to allow share issuances below NAV has an expiration date no more than one year from the date shareholders approve the underlying
proposal, as required under the Investment Company Act of 1940;
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The sale is deemed to be in the best interests of shareholders by (1) a majority of the companys independent directors and (2) a
majority of the companys directors who have no financial interest in the issuance; and
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The company has demonstrated responsible past use of share issuances by either:
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Outperforming peers in its 8-digit GICS group as measured by one- and three-year median TSRs; or
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Providing disclosure that its past share issuances were priced at levels that resulted in only small or moderate discounts to NAV and economic dilution
to existing non-participating shareholders.
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Disposition of Assets/Termination/Liquidation
Vote CASE-BY-CASE on proposals to dispose of assets, to terminate or liquidate, considering the following factors:
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|
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Strategies employed to salvage the company;
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The funds past performance;
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The terms of the liquidation.
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ISS 2012 U.S. Proxy Voting Summary Guidelines
|
|
B-77
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Changes to
the Charter Document
Vote CASE-BY-CASE on changes to the charter document, considering the following factors:
|
|
|
The degree of change implied by the proposal;
|
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|
The efficiencies that could result;
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The state of incorporation;
|
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Regulatory standards and implications.
|
Vote AGAINST any of the following changes:
|
|
|
Removal of shareholder approval requirement to reorganize or terminate the trust or any of its series;
|
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Removal of shareholder approval requirement for amendments to the new declaration of trust;
|
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Removal of shareholder approval requirement to amend the funds management contract, allowing the contract to be modified by the investment
manager and the trust management, as permitted by the 1940 Act;
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Allow the trustees to impose other fees in addition to sales charges on investment in a fund, such as deferred sales charges and redemption fees that
may be imposed upon redemption of a funds shares;
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Removal of shareholder approval requirement to engage in and terminate subadvisory arrangements;
|
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Removal of shareholder approval requirement to change the domicile of the fund.
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Changing the Domicile of a Fund
Vote CASE-BY-CASE on re-incorporations, considering the following factors:
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Regulations of both states;
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Required fundamental policies of both states;
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The increased flexibility available.
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Authorizing the Board to Hire and Terminate Subadvisers Without Shareholder Approval
Vote AGAINST proposals authorizing the board to hire or terminate subadvisers without shareholder approval if the investment adviser currently employs
only one subadviser.
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Distribution Agreements
Vote CASE-BY-CASE on distribution agreement proposals, considering the following factors:
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Fees charged to comparably sized funds with similar objectives;
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The proposed distributors reputation and past performance;
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The competitiveness of the fund in the industry;
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The terms of the agreement.
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Master-Feeder Structure
Vote FOR the establishment of a master-feeder structure.
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Mergers
Vote CASE-BY-CASE on merger proposals, considering the following factors:
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Resulting fee structure;
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Performance of both funds;
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Continuity of management personnel;
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Changes in corporate governance and their impact on shareholder rights.
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Shareholder Proposals for Mutual Funds
Establish Director Ownership Requirement
Generally vote
AGAINST shareholder proposals that mandate a specific minimum amount of stock that directors must own in order to qualify as a director or to remain on the board.
u
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Reimburse Shareholder for Expenses Incurred
Vote CASE-BY-CASE on shareholder proposals to reimburse proxy solicitation expenses. When supporting the dissidents, vote FOR the reimbursement of the proxy solicitation expenses.
u
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u
u
u
Terminate the Investment Advisor
Vote CASE-BY-CASE on proposals to terminate the investment advisor, considering the following factors:
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Performance of the funds Net Asset Value (NAV);
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The funds history of shareholder relations;
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The performance of other funds under the advisors management.
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Disclosure/Disclaimer
This document and all of the information contained in it, including without limitation all text, data, graphs, and charts (collectively, the Information) is the property of Institutional
Shareholder Services Inc. (ISS), its subsidiaries, or, in some cases third party suppliers.
The Information has not been submitted to, nor
received approval from, the United States Securities and Exchange Commission or any other regulatory body. None of the Information constitutes an offer to sell (or a solicitation of an offer to buy), or a promotion or recommendation of, any
security, financial product or other investment vehicle or any trading strategy, and ISS does not endorse, approve, or otherwise express any opinion regarding any issuer, securities, financial products or instruments or trading strategies.
The user of the Information assumes the entire risk of any use it may make or permit to be made of the Information.
ISS MAKES NO EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS WITH RESPECT TO THE INFORMATION AND EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING,
WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS, NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY, AND FITNESS FOR A PARTICULAR PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION.
Without limiting any of the foregoing and to the maximum extent permitted by law, in no event shall ISS have any liability regarding any of the
Information for any direct, indirect, special, punitive, consequential (including lost profits), or any other damages even if notified of the possibility of such damages. The foregoing shall not exclude or limit any liability that may not by
applicable law be excluded or limited.
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2012 Australian Proxy Voting Guidelines
December 19, 2011
Institutional Shareholder
Services Inc.
Copyright
©
2011 by ISS
www.issgovernance.com
B-81
ISS 2012
Australian Proxy Voting Guidelines
Effective for Meetings on or after October 1, 2011 Published Dec. 19, 2011
The following guidelines apply to ASX-registered issuers and those entities listed on the ASX and domiciled in countries not covered by a
separate ISS policy. Furthermore, ISS notes that proxy season for annual general meetings (AGMs) in Australia typically occurs in the October-November timeframe. As such, in light of any potential policy changes that may occur for this
market prior to the upcoming 2012 AGM season, these guidelines may be amended accordingly.
Table of Contents
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INTRODUCTION
The principle underpinning all ISS recommendations is that shareholders are the owners of listed companies.
1
As such, they are entitled to assess every resolution which seeks their approval in terms of how it affects their
interests as the owners of the company.
Overview
Regularly occurring agenda items include:
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Consideration of the financial statements and reports (not normally a voting item);
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Non-binding vote on the remuneration report;
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Approving issue of options (or other equity securities) to directors;
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Approving an increase in the aggregate non-executive director fee cap;
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Approving changes to the companys constitution (requiring a 75-percent majority of votes cast).
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The same principles will be applied to listed entities that are not pure companies, such as trusts and stapled securities.
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GENERAL
Company Name Change
ISS Recommendation: Generally, FOR
ISS views decisions about the company name as best left
to management. Typically, name changes are proposed to align the company name more closely with its primary businesses and activities and/or to simplify the company name. Such changes are usually made without detracting from market recognition of
the companys identity and activities.
Significant Change in Activities
ISS Recommendation: Generally, FOR
ISS
generally recommends FOR resolutions to change the nature or scale of business activities (ASX Listing Rule 11.1) provided the notice of meeting and explanatory statement provide a sound business case for the proposed change.
Capital Structure
Capital structures are generally non-contentious in Australia. Each fully paid ordinary share carries one vote on a poll and equal dividends. Partly paid shares, which are rare, normally carry votes
proportional to the percentage of the share paid-up. Companies may also issue redeemable shares, preference shares, and shares with special, limited, or conditional voting rights. Shares with differing amounts of votes constitute different classes
of shares, but, in practice, shares with limited or enhanced voting rights are seldom, if ever, seen in Australia outside of a handful of externally managed infrastructure entities.
Multiple Voting Rights
ISS Recommendation: Generally, AGAINST
ISS will recommend AGAINST proposals to create a new class of shares with superior voting rights.
Shareholders are better off opposing dual-class proposals on the grounds that they contribute to the entrenchment of management and allow for the
possibility of management acquiring superior voting shares in the future. Empirical evidence also suggests that companies with simple capital structures also tend towards higher valuation because they are easier for investors to understand.
Non-Voting Shares
ISS Recommendation for introduction: CASE-BY-CASE
ISS Recommendation for cancellation:
Generally, FOR
ISS will recommend FOR proposals to create a new class of non-voting or subvoting shares only if:
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It is intended for financing purposes with minimal or no dilution to current shareholders;
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It is not designed to preserve the voting power of an insider or significant shareholder.
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Mergers
and Demergers
ISS Recommendation for introduction: CASE-BY-CASE
ISS will generally recommend FOR mergers and acquisitions, and demergers/spinoffs, unless:
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The impact on earnings or voting rights for one class of shareholders is disproportionate to the relative contributions of the group;
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The companys structure following the acquisition or merger does not reflect good corporate governance;
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There are concerns over the process of negotiation that may have had an adverse impact on the valuation of the terms of the offer.
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ISS will recommend AGAINST if the company does not provide sufficient information upon request to make an informed voting
decision.
Financial Statements
ISS Recommendation: Generally, FOR
ISS will recommend FOR approval of financial statements
and director and auditor reports, unless:
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There are concerns about the accounts presented or the audit procedures used;
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The company is not responsive to shareholder questions about specific items that should be publicly disclosed.
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Australian companies are not required to submit their annual accounts and reports to a shareholder vote.
SHARE CAPITAL
Reduction of Share Capital: Cash Consideration Payable to Shareholders
ISS Recommendation: Generally, FOR
A companys decision to reduce its share capital,
with an accompanying return of funds to shareholders, is usually part of a capital-management strategy. It is commonly an alternative to a buyback or a special dividend.
Such a reduction is normally effected proportionately against all outstanding capital, and therefore does not involve any material change relative to shareholder value. Thus, ISS generally recommends that
shareholders vote for these proposals.
Reduction of Share Capital: Absorption of Losses
ISS Recommendation: Generally, FOR
This
type of capital reduction does not involve any funds being returned to shareholders. A company may take this action if its net assets are in danger of falling below the aggregate of its liabilities and its stated capital. ISS usually supports such
proposals as they are considered to be routine accounting measures.
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Buybacks
ISS Recommendation: Generally, FOR
ISS generally recommends FOR requests to repurchase shares, unless:
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There is clear evidence available of past abuse of this authority;
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It is a selective buyback, and the notice of meeting and explanatory statement does not provide a sound business case for it.
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ISS considers the following conditions in buyback plans: limitations on a companys ability to use the plan to
repurchase shares from third parties at a premium; limitations on the exercise of the authority to thwart takeover threats; and a requirement that repurchases be made at arms-length through independent third parties.
Some shareholders object to companies repurchasing shares, preferring to see extra cash invested in new businesses or paid out as dividends. ISS
considers that when timed correctly, buybacks are a legitimate use of corporate funds and can add to long-term shareholder returns.
Issue of Shares (Placement): Advance Approval
ISS Recommendation: CASE-BY-CASE
The ASX Listing Rules contain a general cap on non-pro rata share issues of 15 percent of total equity in a rolling 12-month period. Listing Rule 7.1
allows shareholders to vote to carve out from the 15-percent-in-12-months cap a particular, proposed issue of shares. If shareholders vote to approve this type of resolution, then the share allotments in question will not be counted in
calculating the 15-percent-in-12-months cap for the company.
Vote CASE-BY-CASE on all requests taking into consideration:
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Dilution to shareholders;
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In some cases, companies may need the ability to raise funds for routine business contingencies without the expense of carrying out a rights issue.
Such contingencies could include the servicing of option plans, small acquisitions, or payment for services. When companies make issuance requests without preemptive rights, shareholders not participating in the placement will suffer dilution. While
conventions regarding this type of authority vary widely among countries, ISS routinely supports issuance requests without preemptive rights for up to 20 percent of a companys outstanding capital;
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Discount/premium in purchase price to the investor;
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Results in a change in control;
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Financing or strategic alternatives explored by the company;
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Arms-length negotiations;
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Conversion rates on convertible equity (if applicable).
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Issue of
Shares (Placement): Retrospective Approval
ISS Recommendation: CASE-BY-CASE
Listing Rule 7.4 allows shareholders to vote to carve out from the 15-percent-in-12-months cap an issue of shares made some time in the previous 12
months. If shareholders vote to approve this type of resolution, then the share allotments in question will not be counted in calculating the 15-percent in-12-months cap for the company.
Australian companies routinely seek approval of previous share distributions. As long as the prior issuances conform to ISS guidelines on share issuances in terms of dilution (see above), we routinely
recommend in favor of such proposals.
BOARD OF DIRECTORS
Director Age Limits
ISS Recommendation: Generally, AGAINST
The Australian Corporations Act no longer includes
an age limit for directors of public companies. ISS supports resolutions seeking to remove the age limitation contained in companies constitutions in order to bring them in line with the Australian Corporations Act.
ISS considers that age should not be the sole factor in determining a directors value to a company. Rather, each directors performance should
be evaluated on the basis of their individual contribution and experience. As long as directors are able to fulfill their fiduciary responsibility to shareholders, ISS does not consider they should be disqualified from remaining in office.
Alteration of the Number of Directors
ISS Recommendation: CASE-BY-CASE
The Australian Corporations Act requires a minimum of
three directors for public companies. There is no maximum limit set out in the Act, although company constitutions may set a maximum limit. ISS considers these proposals on a case-by-case basis, but is generally supportive of resolutions that set a
maximum limit on board size.
ISS generally recommends AGAINST resolutions that seek to remove any maximum limit on board size.
All proposals to alter board size during a proxy fight or other possible contests for control should be opposed. Allowing directors to alter the terms of
a contest while it is under way is not in shareholders interests, as this tactic could be used to thwart a takeover that is in shareholders interests.
Classification of Directors
ISS classifies directors as
executive, non-independent non-executive, or independent non-executive. ISS definition of an independent director uses the Financial Services Council (FSC, formerly the Investment and Financial Services Association or IFSA) definition as its
core. The FSC definition closely reflects the definition used by the ASX Corporate Governance Council. The FSC defines an independent director as a non-executive director who:
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Is not a substantial shareholder (or an executive or associate of a substantial shareholder) of the company;
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Has not within the last three years been employed by the company in an executive capacity, or been a director after ceasing to hold any such
employment;
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Has not within the last three years been a principal or employee of a material professional adviser or material consultant to the corporate group;
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Is not a material supplier/customer of the corporate group (or an executive or associate of a material supplier/customer);
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Does not have a material contractual relationship with the corporate group;
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Is free from any other interest and any business or other relationship with the corporate group.
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ISS interprets this definition as follows:
Substantial Shareholders
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A substantial shareholder is a shareholder controlling 5 percent or more of the voting rights in the company.
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Where a person is a non-executive director of a substantial shareholder, he or she is classified as independent (unless a separate reason exists for
classifying as non-independent). However, if the person is specifically designated as a representative of the substantial shareholder, he or she is classified as non-independent.
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Former Executives
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The three-year rule is treated as a genuine cooling off period. Therefore, a non-executive director is treated as affiliated if he or she
has previously been employed in an executive capacity by the company or another group member, and there was not a period of at least three years between ceasing such employment and serving on the board.
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Advisers, Suppliers, Customers
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Where a person is a non-executive director of a material adviser/supplier/customer, and not a major shareholder (or partner) in the material
adviser/supplier/customer, he or she is classified as independent (unless a separate reason exists for classifying as non-independent).
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The materiality threshold for transactions is A$500,000 per annum for large advisers/suppliers/customers and A$50,000 per annum for small
advisers/suppliers/customers. Large advisers include all major law, accounting and investment banking firms. These thresholds are assessed by looking at transactions during the two most recent financial years.
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Residual
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A company founder is classified as non-independent under the residual category (other interests or relationships) even if he or she is no
longer a substantial shareholder.
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A relative of a substantial shareholder, or of a current or former executive, is classified as non-independent under the residual category.
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If the companys annual report classifies a director as non-independent without further information, he or she is classified as non-independent
under the residual category.
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There is no hard and fast rule about tenure (length of time on the board) impacting independence. However, a non-executive director who has served 20
or more years would be classified as non-independent under the residual category.
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Election
of Directors
ISS considers the overall composition of the board, and of the audit, remuneration, and nomination committees, as well as
individual directors attendance records.
ISS will also consider the history of a particular director when deciding whether to recommend
in favor of their (re)election. Examples of circumstances where ISS will consider recommending AGAINST a directors (re)election, regardless of board composition, are when a director has had significant involvement with a failed company and/or
where a director has in the past appeared not to have acted in the best interests of all shareholders.
Where there is a majority-independent
board (greater than 50 percent), ISS will recommend FOR the (re)election of a board-nominated director unless:
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He or she is executive and chairperson, and no lead director has been appointed from among the independent directors (recommend AGAINST;
but if he or she is company founder and integral to the company, recommend FOR);
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He or she is executive (but not the CEO) and is on the audit committee (recommend AGAINST);
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He or she is non-independent due to being a former partner or employee of the companys auditor, and is on audit committee (recommend AGAINST);
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He or she is executive (but not the CEO) and is on the remuneration committee, and the remuneration committee is not majority-independent (recommend
AGAINST);
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He or she has attended less than 75 percent of board and committee meetings over the most recent two years, without a satisfactory explanation
(recommend AGAINST);
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He or she sits on more than five other listed company boards (counting a chair as equivalent to two board positions), or is an executive director and
holds more than one non-executive directorship at unrelated listed companies (recommend AGAINST, in the absence of exceptional circumstances).
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Where there is not a majority-independent board (less than or equal to 50 percent):
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Generally recommend AGAINST executive directors (except the CEO and founders integral to the company) because executives do not need to sit on the
board for directors to access their expertise. It is common in Australia for senior executives to be invited to board meetings to make presentations and answer questions;
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Recommend AGAINST a representative of a substantial shareholder on a board where the reason independent directors constitute a minority of the board is
because of a preponderance of executive directors and representatives of one substantial shareholder. In these cases, ISS will recommend against only one representative of the substantial shareholder (typically, the director with the worst
attendance record);
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Recommend AGAINST any director who is non-independent due to being a former partner or employee of the companys auditor, and is on the audit
committee;
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Recommend AGAINST any director who has attended less than 75 percent of board and committee meetings over the most recent two years, without a
satisfactory explanation;
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Recommend AGAINST any director who sits on more than five other listed company boards (counting a chair as equivalent to 2 board positions), or is an
executive director and holds more than one non-executive directorship at unrelated listed companies, unless exceptional circumstances exist.
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Recommend AGAINST shareholder-nominated
candidates who lack board endorsement, unless they demonstrate a clear ability to contribute positively to board deliberations.
Under
extraordinary circumstances, recommend AGAINST directors individually, on a committee, or the entire board, due to:
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Material failures of governance, stewardship, risk oversight, or fiduciary responsibilities at the company; or
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Failure to replace management as appropriate; or
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Egregious actions related to the director(s) service on other boards that raise substantial doubt about his or her ability to effectively oversee
management and serve the best interests of shareholders at any company.
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Combination of CEO
and Chairperson
ISS Recommendation: CASE-BY-CASE
ISS supports the separation of the roles of chairperson and CEO in principle but acknowledges that there may be certain mitigating factors to counterbalance a board structure where the roles are combined,
such as the appointment of a lead director. ISS also considers companies should be allowed the discretion in exceptional circumstances to temporarily combine the roles if adequate justification is provided. If the company combines these two
positions into one person, then the company must provide for adequate control mechanisms.
Removal of
Directors
ISS Recommendation: CASE-BY-CASE
The major decision factors are:
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Company performance relative to its peers;
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Strategy of the incumbents versus the dissidents;
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Independence of directors/nominees;
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Experience and skills of board candidates;
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Governance profile of the company;
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Evidence of management entrenchment;
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Responsiveness to shareholders.
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REMUNERATION
Remuneration
Report
ISS Recommendation: CASE-BY-CASE
ISS approach is to ascertain, from the remuneration report, the key positive and negative features of the companys approach to executive and non-executive remuneration, and then make a voting
recommendation after balancing those positive and negative features. An assessment is made of both (a) the way in which the company pays its executives and non-executive directors and (b) the adequacy and quality of the companys
disclosure.
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In relation to (a), ISS approach to
long-term incentive plans and option plans is covered in Remuneration of Executives: Options and Other Long-Term Incentives below.
Remuneration of Non-Executive Directors: Increase in Aggregate Fee Cap
ISS Recommendation: CASE-BY-CASE
This
type of resolution seeks shareholder approval for an increase in the maximum aggregate level of fees able to be paid to the companys non-executive directors. It is a requirement of the ASX Listing Rules for companies to obtain shareholder
approval for any increase in the fee cap.
When assessing requests for an increase in the fee cap, ISS applies a case-by-case approach taking
into account the following factors:
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The size of the proposed increase;
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The level of fees compared to those at peer companies;
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The explanation the board has given for the proposed increase;
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Whether the company has discontinued retirement benefits;
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The companys absolute and relative performance over (at least) the past three years based on measures such as (but not limited to) share price,
earnings per share and return on capital employed;
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The companys policy and practices on non-executive director remuneration, including equity ownership;
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The number of directors presently on the board and any planned increases to the size of the board;
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The level of board turnover.
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If the company has an active retirement benefits plan for non-executive directors, recommend AGAINST the increase. ISS also will recommend AGAINST a fee cap increase where a company is seeking an increase
after a period of poor absolute and relative performance, where the same board (or largely the same board) has overseen this period of poor performance and where the fee cap increase is not being sought for the purposes of board renewal.
Remuneration of Non-Executive Directors: Approval of Share Plan
ISS Recommendation: Generally, FOR
This
type of resolution seeks shareholder approval for the companys non-executive directors to receive some of their fees in the form of shares rather than cash. The reason for the resolution is that listed companies can only issue equity
securities to directors if shareholders approve such issuances in advance (Listing Rule 10.14).
The ISS recommendation in such cases is
generally FOR because all three key sets of guidelines in Australia (ASX Corporate Governance Council, FSC, and those of the Australian Council of Super InvestorsACSI) support companies taking steps to encourage non-executive directors to
acquire a material shareholding.
Remuneration of Executive Directors: Share Incentive Schemes
ISS Recommendation: CASE-BY-CASE
ISS
takes a similar approach to share incentive schemes as it does to share option plans (see Remuneration of Executives: Options and Other Long-Term Incentives below).
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Share incentive schemes in Australia
usually provide for performance rights, performance shares, conditional rights, or similar instruments, all of which are economically zero exercise price options (ZEPOs).
A smaller number of share incentive schemes are structured as loan-funded share plans.
Remuneration of Executives: Options and Other Long-Term Incentives
ISS Recommendation: CASE-BY-CASE
In Australia, there is no statutory or listing rule
requirement for companies to put share option plans or other long-term incentive plans before shareholders for approval. Some companies choose to seek shareholder approval of a plan so that options or other equity instruments issued under it do not
count towards the 15 percent in 12 months dilution cap (see Issue of Shares (Placement): Advance Approval, above).
Under ASX Listing Rule 10.14, companies must seek shareholder approval for any grant of options or shares to a director. However, there is a carve-out
for grants of shares where those shares were purchased on-market rather than being newly issued. This carve-out was introduced in a controversial amendment to Listing Rule 10.14 in October 2005. In ISS viewreflecting the views of many
institutional investors in Australiathe carve-out is inappropriate, and long-term incentive grants of shares to executive directors should be put to shareholders for a vote, regardless of whether the shares are newly issued or purchased on
market. If a company utilizes the Listing Rule 10.14 carve-out, this is treated as a negative factor in ISS assessment of the Remuneration Report.
ISS reviews long-term incentive plans and share option plans (and proposed grants of options and shares to particular directors) according to the following criteria:
Exercise Price
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Option exercise prices should not be at a discount to the market price at the grant date. (Many Australian companies now issue performance rights or
performance shares, which are ZEPOs. These are not treated as discounted options, but the following requirements in terms of vesting period, performance hurdles, etc, apply equally.)
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Plans should not allow the repricing of underwater options.
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Vesting Period
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Should be appropriate time restrictions before options can be exercised (if 50 percent or more of securities can vest in two years or less, this is too
short).
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Performance Hurdles
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Generally, a hurdle that relates to total shareholder return (TSR) is preferable to a hurdle that specifies an absolute share price target or an
accounting measure of performance (such as earnings per share: EPS).
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Where a relative hurdle is used (comparing the companys performance against a group of peers or against an index), no vesting should occur for
submedian performance, and the peer group should be defensible (e.g. not too small, and not cherry picked).
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A sliding-scale hurdle under which the percentage of options/rights that vest increases according to a sliding scale of performance (whether
absolute or relative) is generally preferable to a hurdle under which 100 percent of options vest once a single target is achieved.
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Where an absolute share-price target is used, executives can be rewarded by a rising market even if their company does relatively poorly. In addition,
even if a share-price hurdle is set at a significantly higher level than the prevailing share price, then the hurdle may not be particularly stretching if the option has a long life and there are generous retesting provisions.
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An accounting-related hurdle does not necessarily require that shareholder value be improved before the incentive vests. In other words, with an
accounting performance hurdle, it is possible for incentives to vest and executives to be rewarded without any medium to long-term improvement in shareholder return having been delivered. Growth in EPS may, but does not always,
translate into a material increase in share price and dividends over the medium to long-term.
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Two different types of options should be distinguished: (1) grants of market-exercise-price options (traditional options), and (2) ZEPOs.
Traditional options have an in-built share price appreciation hurdle, because the share price must increase above its level at the grant date for the executive to have an incentive to exercise. ZEPOs have no exercise price; the executive pays
nothing to the company on exercising the rights. An EPS hurdle can lead to executive reward without any increase in shareholder return if the instruments are ZEPOs, but not if they are traditional options. Therefore, an EPS hurdle can more readily
be supported if traditional options, rather than ZEPOs, are being granted.
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For an EPS target to be sufficiently stretching, the target should specify a hurdle that will require EPS to have grown significantly. In assessing
whether an EPS hurdle is sufficiently stretching for a particular company, ISS will consider the EPS forecasts for a particular company produced and published by analysts and any earnings guidance provided by management. If a sliding-scale EPS
hurdle is used, a significant proportion of the options should vest only for EPS performance that exceeds consensus analyst forecasts.
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Retesting
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A retest is where the performance hurdle has not been achieved during the initial vesting period, and the plan permits further testing of the
performance hurdle on a later date or dates. Many investors in markets like the U.K. do not support retesting of performance criteria on share options or other share-based incentive awards, arguing that retesting undermines the incentive value of
such awards. However, such provisions have not been uncommon in the Australian market. At the same time, however, as companies have moved towards annual grants of awards that mitigate the concerns over cliff-vesting and the increasingly
held view among institutions that retesting does not constitute best practice, companies are encouraged to review such practices and move towards reducing the number of retests to a small number, if not eliminating retesting altogether.
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In cases where retesting exists, ISS will evaluate the type of retesting, either fixed-base or rolling, and the frequency of the retesting. (Fixed-base
testing means performance is always tested over an ever-increasing period, starting from grant date. This is less concerning than retesting from a rolling start date.) Where a company has a particularly generous retesting regime, and has not
committed to reduce the number of retests to a small number, ISS will recommend AGAINST a resolution to approve the scheme in question, or a grant of options/rights under the scheme. This may also lead to an AGAINST recommendation on the
remuneration report, depending on other aspects of executive and non-executive pay. In the case of new plans, ISS considers that companies should not include retesting provisions as a matter of best practice, but will take a case-by-case approach in
such instances.
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ISS 2012 Australian Proxy Voting Guidelines
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B-94
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Transparency
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Methodology for determining exercise price should be disclosed.
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Shareholders should be presented with sufficient information to determine whether the scheme will reward superior future performance.
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Proposed volume of securities which may be issued should be disclosed to enable shareholders to assess dilutionary impact.
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Time restrictions before options can be exercised should be disclosed.
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Any restrictions on disposing of shares received should be disclosed.
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Full cost of options to the company should be disclosed.
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Method used to calculate cost of options should be disclosed, including any discount applied to account for the probability of equity incentives not
vesting.
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Method of purchase or issue of shares on exercise of options should be disclosed.
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Dilution of Existing Shareholders Equity
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Aggregate number of shares and options issued under all employee and executive incentive schemes should not exceed 10 percent of issued capital.
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Level of Reward
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Value of options granted (assuming performance hurdles are met) should be consistent with comparable schemes operating in similar companies.
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Eligibility for Participation in the Scheme
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Scheme should be open to all key executives.
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Scheme should not be open to non-executive directors.
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Other
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Plans should include reasonable change-in-control provisions (i.e. pro rata vesting time and size of awards).
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Plans should include good leaver/bad leaver provisions to minimize excessive and unearned payouts (see below for a discussion
of ISS specific approach to resolutions seeking approval for termination benefits to executives generally and under equity plans).
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In summary, ISS generally opposes plans, and proposed grants under plans, if any of the following apply:
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Exercise price is discounted;
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Vesting period is too short;
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Performance hurdles are not sufficiently demanding (although ISS will take into account whether the plan is used for a wide group of employees in
evaluating performance hurdles under a particular plan);
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ISS 2012 Australian Proxy Voting Guidelines
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B-95
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Extensive retesting of performance criteria is permitted over an extended time period if the original performance criteria are not met during the
initial testing period;
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Plan allows for excessive dilution;
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Company failed to disclose adequate information regarding any element of the scheme.
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Long-Term Incentive Plan Amendments
ISS recommendation: CASE-BY-CASE
When evaluating amendments to existing plans ISS
initially uses its long-term incentive plan guidelines (see above). ISS then determines if the amendment is improving/removing negative features or if it is exacerbating such features. If the amendment is eliminating negative features, the amendment
could potentially be supported. However, if the amendment is neutral, ISS would recommend AGAINST the amendment to express dissatisfaction with the underlying terms of the plan.
Termination benefit approvals
ISS recommendation:
CASE-BY-CASE
Amendments to the Australian Corporations Act in November 2009 capped allowable (i.e. without shareholder approval)
termination benefits to senior executives at 12 months base pay. Formerly the Corporations Act required shareholder approval only where the termination payment was in excess of seven times total remuneration. Companies are able to
seek approval of such payments, including benefits from unvested equity grants on termination, in advance including by seeking general approval for vesting of equity incentives on termination under a specific equity plan.
ISS will generally recommend AGAINST resolutions seeking approval of termination payments for executives in excess of the statutory maximum (i.e. 12
months base pay), except where there is clear evidence that the termination payment would provide a benefit to shareholders.
In cases
where approval is sought for termination benefits under any equity plan, vote FOR the provision of termination benefits under the plan in excess of 12 months base salary, only if the approval is for three years or less and no vesting without
satisfaction of sufficiently demanding performance hurdles is permitted.
AUDITORS
Reappointment of Auditor, and Authorization for the Directors to Set Auditors Remuneration
ISS Recommendation: Generally, FOR
This
type of resolution is not required under Australian law, and so it arises for ASX-listed companies that are incorporated in the United Kingdom, Papua New Guinea, and other countries where annual reappointment of the auditor is a statutory
requirement.
ISS will recommend FOR appointment of auditors and authorizing the board to fix their remuneration, unless:
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There are serious concerns about the accounts presented or the audit procedures used;
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Non-audit related fees are substantial or are routinely in excess of standard annual audit fees.
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ISS 2012 Australian Proxy Voting Guidelines
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B-96
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Appointment of a New Auditor
ISS Recommendation: Generally, FOR
Whenever an Australian public company changes its
auditor during the year, it is required to put the auditor up for election by shareholders at the next AGM. Often a new auditor is selected by the board during the year and may or may not have started work by the time the shareholders vote on its
election.
Unless there is some compelling reason why a new auditor selected by the board should not be endorsed, the recommendation is FOR. A
compelling reason might be a past association as auditor during a period of financial trouble.
MISCELLANEOUS
Constitutional Amendment
ISS Recommendation: CASE-BY-CASE
Proposals to amend the companys constitution are
required to be approved by a special resolution (75-percent majority of votes cast).
Proposals range from a general updating of various
clauses to reflect changes in corporate law and ASX Listing Rules, to complete replacement of an existing constitution with a new plain language, and updated, version.
Renewal of Proportional Takeover Clause in Constitution
ISS Recommendation: Generally, FOR
The Australian Corporations Act allows a company to
include in its constitution a clause which requires shareholder approval for a proportional (partial) takeover offer to be made. Under this type of clause, a proportional takeover offer cannot proceed to be mailed out to shareholders until after the
company has held a general meeting at which shareholders vote on whether to allow the offer to be made. The clause can remain in the constitution for a maximum of three years. It is standard practice among ASX-listed companies to ask their
shareholders to reinsert the clause into the constitution, at every third AGM. The clause cannot be used as a management entrenchment device given that if a shareholder meeting to vote on the approval of the making of a proportional bid is not held
within 14 days of the bid expiry deadline, allowing the bid to be made will be taken as approved.
DISCLOSURE/DISCLAIMER
This document and all of the information contained in it, including without limitation all text, data, graphs, and charts (collectively, the Information) is the property of Institutional
Shareholder Services Inc. (ISS), its subsidiaries, or, in some cases third party suppliers. The Information may not be reproduced or redisseminated in whole or in part without prior written permission of ISS.
The Information has not been submitted to, nor received approval from, the United States Securities and Exchange Commission or any other regulatory body.
None of the Information constitutes an offer to sell (or a solicitation of an offer to buy), or a promotion or recommendation of, any security, financial product or other investment vehicle or any trading strategy, and ISS does not endorse, approve
or otherwise express any opinion regarding any issuer, securities, financial products or instruments or trading strategies.
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ISS 2012 Australian Proxy Voting Guidelines
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B-97
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The user of the Information assumes the
entire risk of any use it may make or permit to be made of the Information.
ISS MAKES NO EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS
WITH RESPECT TO THE INFORMATION AND EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING, WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS, NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY AND FITNESS FOR A PARTICULAR
PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION.
Without limiting any of the foregoing and to the maximum extent permitted by law, in no
event shall ISS have any liability regarding any of the Information for any direct, indirect, special, punitive, consequential (including lost profits) or any other damages even if notified of the possibility of such damages. The foregoing shall not
exclude or limit any liability that may not by applicable law be excluded or limited.
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ISS 2012 Australian Proxy Voting Guidelines
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B-98
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2012 Canadian Proxy Voting Guidelines
TSX-Listed Companies
December 19, 2011
Institutional Shareholder Services Inc.
Copyright
©
2011 by ISS
www.issgovernance.com
B-99
ISS 2012 Canadian
Proxy Voting Guidelines- TSX Companies
Effective for Meetings on or after Feb. 1, 2012
Published Dec. 19, 2011
TABLE OF CONTENTS
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-100
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-101
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INTRODUCTION
The primary purpose of a public corporation is to create sustainable value for its shareowners. To that end, ISS designs its proxy voting guidelines to
enhance shareholders long-term economic interests. ISS Benchmark proxy voting guidelines serve as a tool to assist institutional investors in meeting their fiduciary requirements with respect to voting by promoting shareholder value
creation and risk mitigation at their portfolio firms.
ISS reviews and updates its proxy voting guidelines each year, taking into account
emerging issues and trends, the evolution of market standards, regulatory changes, and feedback provided by ISS institutional clients.
ISS robust and transparent
policy formulation process
includes an exhaustive review of relevant empirical studies and other factual data, an
annual
policy survey
of institutional clients and corporate issuers, policy roundtables with a wide range of industry constituents, and an open
comment period
on draft policy changes. ISS also conducts internal research to validate
assumptions and policy positions.
The Benchmark Policy Guidelines consider market-specific recommended best practices, transparency, and
disclosure when addressing issues such as board structure, director accountability, corporate governance standards, executive compensation, shareholder rights, corporate transactions, and social/environmental issues.
ISS policy guidelines require the consideration of company-specific circumstances. When issuing a vote recommendation on a proposal, ISS considers
historical operating and investment performance, company disclosure (and proponent/dissident disclosure, if applicable), the companys governance structure and historical practices, and its industry.
In applying these policies, ISS often engages with public issuers, shareholders, activists, and other stakeholders to seek additional information and to
gain insight and context in order to provide our clients with informed vote recommendations. This engagement process enhances dialogue and promotes a higher level of understanding between investors and the companies in which they invest.
In formulating proxy voting policies, ISS assesses the potential costs and benefits of the adoption or rejection of the underlying ballot items. Where
the economic impact of a ballot item is not apparent and may involve trade-offs, the guidelines direct analysts to consider the economic consequences as well as potential risks to shareholders of approval.
This document presents ISS Benchmark Canadian Corporate Governance Policies for TSX-listed companies. The document, along with other policy
documents, is available on our Web site under the
Policy Gateway
. If you have any questions, please contact
ca-research@issgovernance.com
.
These policies will be effective for meetings on or after Feb. 1, 2012.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-102
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1.
Routine/Miscellaneous
Audit-Related
Financial Statements/Director and Auditor Reports
Companies
are required under the CBCA to submit their financial statements and the auditor report, which is included in the companys annual report, to shareholders at every AGM. This routine item is almost always non-voting.
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Ratification of Auditors
Vote FOR proposals to ratify auditors, unless the following applies:
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Non-audit related fees paid to the auditor exceed audit-related fees.
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RATIONALE: Multilateral Instrument 52-110 relating to Audit Committees defines audit services to include the professional services rendered by the issuers external auditor for the audit
and review of the issuers financial statements or services that are normally provided by the external auditor in connection with statutory and regulatory filings or engagements.
The Instrument also sets out disclosure requirements related to fees charged by external auditors. Every issuer is required to disclose in their Annual Information Form with at least a cross-reference in
the related Proxy Circular, fees billed by the external audit firm in each of the last two fiscal years, broken down into four categories: Audit Fees, Audit-Related Fees, Tax Fees, and All Other Fees.
In circumstances where Other fees include fees related to significant one-time capital structure events: initial public offerings, bankruptcy
emergence, and spin-offs; and the company makes public disclosure of the amount and nature of those fees which are an exception to the standard non-audit fee category, then such fees may be excluded from the non-audit fees considered in
determining the ratio of non-audit to audit/audit-related fees/tax compliance and preparation for purposes of determining whether non-audit fees are excessive.
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Other Business
Vote AGAINST all proposals on proxy ballots seeking approval for unspecified other business that may be conducted at the shareholder meeting.
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2. Board of Directors
Slate Ballots (Bundled director elections)
Generally WITHHOLD
votes from all directors nominated by slate ballot at the annual/general or annual/special shareholders meetings of TSX reporting issuers where ISS has identified (i) additional corporate governance practices that fall short of best
practice for the Canadian market; or (ii) concerns about compensation practices and the alignment of pay with performance. This policy will not apply to contested director elections.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-103
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Any one of the following board-related
governance practices in addition to a slate ballot which has the effect of insulating directors from shareholder votes may result in a WITHHOLD:
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Less than majority independent board;
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Less than majority independent key committees;
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Insiders on key committees;
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Lack of separate nominating or compensation committee;
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Less than 75% director attendance without acceptable reason, or director attendance has not been disclosed;
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No disclosure of audit fees broken down by category as required by regulatory disclosure rules;
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Non-audit fees (Other fees) paid to the external audit firm exceed audit and audit-related fees;
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Former CEO/CFO on the audit or compensation committee;
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Lack of independent Chairman of the Board or independent Lead Director identified; or
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The
following may also be taken into consideration and contribute to a WITHHOLD from the entire slate:
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Dual Class Capital Structure (common share capital structure with unequal voting rights);
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Pay for performance disconnect;
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Problematic pay practices;
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Performance concerns as indicated by TSR in the bottom half of the companys GICS group median;
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Disclosure concerns; or
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Other significant corporate governance concerns.
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The above policy may not apply if the company has:
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Graduated in the last year from the TSX Venture Exchange to the TSX; or
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Committed to replace slate director elections with individual director elections within a year.
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RATIONALE
:
A companys relationship with its shareholders and how it allows shareholders to vote for its directors are the foundation of its
corporate governance structure. Fewer of Canadas largest issuers continue to elect directors by slate ballot, in response to shareholder concerns regarding their inability to express approval or disapproval for individual directors. The number
of slate ballots has declined significantly over the past year making this form of ballot a dying trend.
This policy will have a double
trigger: a slate election together with any one corporate governance concern listed in the policy will warrant a withhold vote recommendation. This double trigger addresses the fundamental concern with slate director elections: they discourage
shareholders from providing feedback through director elections and they effectively shield directors from shareholder disapproval. The policy will remove the protective shield of slate elections at companies with questionable corporate governance
practices.
Shareholders should have the ability to vote for their choice of directors individually from either ballot in a contested election
so that the resulting board of directors truly reflects the wishes of a majority of the
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-104
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shareholders. ISS evaluates proxy contests primarily based on an assessment of the need for change, and which slate of nominees is most likely to provide the greatest shareholder value going
forward. Although corporate governance practices can be a key determinant in the decision to support one side or the other, most often the decision is based on company performance and director qualifications. This, in addition to the ongoing
challenges with the mechanics of proxy voting, particularly in the case of highly contentious proxy contests, leads us to believe that it is appropriate to carve contested elections out of this policy.
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Voting on Director Nominees in Uncontested Elections
The following fundamental principles apply when determining votes on director nominees:
Board
Accountability:
Practices that promote accountability and enhance shareholder trust begin with transparency into a companys governance practices including risk management practices. These practices include the annual election of all
directors by a majority of votes cast by all shareholders and provide shareholders with the ability to remove problematic directors, and include the detailed timely disclosure of voting results. Board accountability is facilitated through clearly
defined board roles and responsibilities, regular peer performance review and shareholder engagement.
Board Responsiveness:
In
addition to facilitating constructive shareholder engagement, boards of directors should be responsive to the wishes of shareholders as indicated by majority supported shareholder proposals or lack of majority support for management proposals
including election of directors. In the case of a company controlled through a dual-class share structure, the support of a majority of the minority shareholders should equate to majority support.
Board Independence:
Independent oversight of management is a primary responsibility of the board and while true independence of thought and deed
is difficult to assess, there are corporate governance practices with regard to board structure and management of conflicts of interest that are meant to promote independent oversight. Such practices include the selection of an independent chair to
lead the board; structuring board pay practices to eliminate the potential for self-dealing, reduce risky decision-making and ensure the alignment of director interests with those of shareholders rather than management; structure separate
independent key committees with defined mandates. Complete disclosure of all conflicts of interest and how they are managed is a critical indicator of independent oversight.
Board Capability:
The skills, experience and competencies of board members should be a priority in director selection, but consideration should also be given to a board candidates ability to
devote sufficient time and commitment to the increasing responsibilities of a public company director. Directors who are unable to attend board and committee meetings and/or who are overextended (i.e., serving on too many boards) raise concern
regarding the directors ability to effectively serve in shareholders best interests.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-105
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ISS
Canadian Definition of Independence
Inside Director (I)
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Employees of the Company or its affiliates
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Non-employee officer of the Company if he/she is among the five most highly compensated;
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Beneficial owner of Company shares with more than 50% of the outstanding voting rights.
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Affiliated Outside Director (AO)
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Former executive with the Company within the last three years (excluding CEO);
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Former CEO (no cooling off period);
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Former interim CEO if the service was longer than 18 months or if the service was between 12 and 18 months and the compensation was high relative to
that of the other directors (5x their pay) or in line with a CEOs compensation
2
;
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Former executive of the Company, an affiliate or a firm acquired within the past three years;
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Executive of a former parent or predecessor firm at the time the Company was sold or split off from parent/predecessor (subject to three year cooling
off other than CEO);
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Executive, former executive with last three years, general or limited partner of a joint venture or partnership with the Company;
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Relative
3
of current executive officer
4
of the Company;
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Relative of a person who has served as an executive officer of the Company within the last three years;
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Currently provides (or a relative provides) professional services to the Company or to its officers;
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Currently employed by (or a relative is employed by) a significant customer or supplier
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;
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Is (or a relative is) a trustee, director or employee of a charitable or non-profit organization that receives grants or endowments from the Company;
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Has (or a relative has) a transactional relationship with the Company excluding investments in the Company through a private placement;
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Has a contractual/guaranteed board seat and is party to a voting agreement to vote in line with management on proposals being brought to shareholders;
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Founder
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of the Company but not currently an employee;
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Board attestation that an outside director is not independent.
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Independent Directors (IO)
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No
material
7
ties to the corporation other than board seat.
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Affiliate includes a subsidiary, sibling company, or parent company. ISS uses 50 percent control ownership by the parent company as the
standard for applying its affiliate designation.
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ISS will look at the terms of the interim CEOs compensation or employment contract to determine if it contains severance pay, long-term health
and pension benefits or other such standard provisions typically contained in contracts of permanent, non-temporary CEOs. ISS will also consider if a formal search process was underway for a full-time CEO.
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Relative refers to immediate family members including spouse, parents, children, siblings, in-laws and anyone sharing the directors home.
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Based on the definition of Executive Officer used in Multilateral Instrument 52-110.
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If the company makes or receives annual payments exceeding the greater of $200,000 or 5 percent of recipients gross revenues (the recipient is
the party receiving proceeds from the transaction).
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The operating involvement of the Founder with the company will be considered. Little or no operating involvement may cause ISS to deem the Founder as
an independent outsider.
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Material is defined as a standard of relationship (financial, personal or otherwise) that a reasonable person might conclude could
potentially influence ones objectivity in the boardroom in a manner that would have a meaningful impact on an individuals ability to satisfy requisite fiduciary standards on behalf of shareholders.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-106
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Vote CASE-BY-CASE on director nominees,
examining the following factors when disclosed:
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Independence of the board and key board committees;
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Attendance at board and committee meetings;
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Corporate governance provisions and takeover activity;
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Long-term company performance;
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Directors ownership stake in the company;
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Compensation practices;
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Responsiveness to shareholder proposals;
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Board accountability; and
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Adoption of a Majority Voting (director resignation) policy.
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Board Structure and Independence
Generally vote WITHHOLD from
any insider or affiliated outside director (and the whole slate if the slate includes such individual directors) where:
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The board is less than majority independent, OR
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The board lacks a separate compensation or nominating committee.
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RATIONALE: The balance of board influence should reside with independent directors free of any pressures or conflicts which might prevent them from objectively overseeing strategic direction, evaluating
management effectiveness, setting appropriate executive compensation, maintaining internal control processes and ultimately driving long-term shareholder value creation. Best practice corporate governance standards do not advocate that no inside
directors sit on boards. Company insiders have extensive company knowledge and experience that provides a significant contribution to business decisions at the board level. In order to maintain the independent balance of power necessary for
independent directors to fulfill their oversight mandate and make difficult decisions that may run counter to managements self-interests, insiders, former insiders and other related directors should not dominate the board or continue to be
involved on key board committees charged with the audit, compensation and nomination responsibilities.
Best practice as set out in National
Policy 58-201 Corporate Governance Guidelines recommends that the board should have:
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A majority of independent directors.
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A nominating committee and a compensation committee composed entirely of independent directors (Nomination of Directors 3.10; Compensation 3.15).
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Guideline Six of the CCGG publication 2010 Building High Performance Boards indicates that boards
Establish mandates for board committees and ensure committee independence. It is further recommended that key board committees review committee charters every year and amend or confirm the mandate and procedures based on
information received from the board and committee evaluation process.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-107
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Insiders
on Key Committees
Vote WITHHOLD from individual directors (and the whole slate if the slate includes such individual directors) who:
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Are insiders on the audit, compensation or nominating committee.
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Include cautionary language for all affiliated outside directors who sit on the audit, compensation or nominating committee, to the effect that corporate governance best practices dictate that such
committees should be comprised entirely of independent directors.
RATIONALE: In order to promote independent oversight of management, the
board as a whole and its key board committees should meet minimum best practice expectations of no less than majority independence. Director elections are seen to be the single most important use of the shareholder franchise.
Multilateral Instrument 52-110 Audit Committees sets out best practice with regard to the composition of the audit committee. The Instrument requires
that every reporting issuer, other than an investment fund, issuer of asset-backed securities, designated foreign issuer, SEC issuer, or issuers that are subsidiary entities as long as the subsidiary does not issue securities and the parent is
subject to compliance with this instrument, must have an audit committee and that the committee must comprise a minimum of three members and that every audit committee member must be independent.
Audit Fee Disclosure
Generally vote WITHHOLD from the members of the Audit Committee as reported in the most recently filed public documents if:
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No audit fee information is disclosed by the Company within a reasonable period of time prior to a shareholders meeting at which ratification of
auditors is a voting item.
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RATIONALE: In addition to audit fee disclosure by category now being a regulatory requirement,
such information is of great importance because of the concern that audit firms could compromise the independence of a company audit in order to secure lucrative consulting services from the company.
Excessive Non-Audit Fees
Generally vote WITHHOLD from individual directors (and the whole slate if the slate includes such individual directors)who are members of the Audit Committee as constituted in the most recently completed
fiscal year if:
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Non-audit fees (Other Fees) paid to the external audit firm exceed audit and audit-related fees.
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RATIONALE: Part 2 of Multilateral Instrument 52-110 Audit Committees states that the audit committee must be directly responsible for overseeing the work
of the external auditor and the audit committee must pre-approve all non-audit services provided to the issuer or its subsidiary entities by the issuers external auditor. It is therefore appropriate to hold the audit committee accountable for
payment of excessive non-audit fees.
Meeting Attendance
Vote WITHHOLD from individual director nominees if:
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(i) The company has NOT adopted a majority voting policy and (ii) the individual director has attended less than 75% of the board and committee
meetings
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held within the past year without a valid reason
for these absences;
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Where a WITHHOLD is based on meeting attendance for board meetings only due to lack of disclosure on committee meeting attendance, particulars will be
provided in the analysis.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-108
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(i) The company has adopted a majority voting policy and (ii) the individual director has attended less than 75% of the board and committee
meetings held within the past year without a valid reason for the absences
AND
a pattern of low attendance exists based on prior years meeting attendance.
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The following should be taken into account:
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Valid reasons for absence at meetings include illness or absence due to company business;
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Participation via telephone is acceptable;
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If the director missed one meeting or one days meetings, votes should not be withheld even if such absence dropped the directors attendance
below 75%;
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Board and committee meetings include all regular and special meetings of the board duly called for the purpose of conducting board business;
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Out of country location or residence is not a sufficient excuse not to attend board meetings, especially given technological advances in communications
equipment.
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RATIONALE: Corporate governance best practice supports board structures and processes that promote independent
oversight and accountability. Nominating competent, committed and engaged directors to the board also necessitates full participation in the conduct of board business in order to fulfill the many responsibilities and duties now required to meet
requisite standards of care. A director who commits to serve on a public company board should be prepared and able to make attendance at and contribution to the boards meetings a priority. A pattern of absenteeism may be an indicator of a more
serious concern with a directors ability to serve, warranting a board review and potentially the directors resignation.
Overboarded Directors
Directors are overboarded if they sit on a number of boards which could result in excessive time commitments and
an inability to carry out their oversight duties. Cautionary language will be included regarding the number of additional public company board seats held by directors if:
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The director is a CEO and sits on more than
2
outside public company boards in addition to his/her own company.
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The director is an outside professional director and sits on more than
6
public company boards in total.
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National Policy 58-201 Corporate Governance Guidelines, state that they are not meant to be prescriptive and that issuers are encouraged to consider the
guidelines in developing their own corporate governance practices. Further that The Policy provides guidance that has been formulated to be sensitive to the realities of the greater numbers of small companies and controlled companies in the
Canadian corporate landscape. NP 58-201 does not address the number of boards appropriate for directors but simply instructs that the board should appoint a Nominating Committee and that one of the Committees duties should be to consider
whether or not each new nominee can devote sufficient time and resources to his or her duties as a board member.
2010 Building High
Performance Boards published by the Canadian Coalition for Good Governance indicates that, directors who hold a full-time executive position should have only one or two outside public company directorships
and that directors who are not
employed full time should generally hold no more than four outside corporate directorships that take up a significant amount of time.
The
Pension Investment Association of Canadas Corporate Governance Principles state more generally that In order for directors to devote the required amount of time to their board responsibilities, they must limit the
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-109
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number of other directorships that they accept. But PIAC does not specify what an acceptable number might be, presumably in recognition of Canadas more flexible comply-or-explain
governance regime.
Former CEO/CFO on Audit/Compensation Committee
Generally vote WITHHOLD from any director on the Audit or Compensation committee if:
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The director has served as the CEO of the company at any time,
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The director has served as the CFO of the company within the past three years.
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RATIONALE: Although such directors are designated as affiliated outsiders under ISS policy, a WITHHOLD vote will be recommended as if they were insiders
on these key committees due to concerns of independent oversight of financials for which they were previously responsible or compensation arrangements that they may have orchestrated and over which they may still wield considerable influence thus
potentially compromising the Audit or Compensation Committees independence.
Voting on Directors for
Egregious Actions
Under extraordinary circumstances, vote WITHHOLD from directors individually, one or more committee members, or the
entire board, due to:
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Material failures of governance, stewardship, risk oversight or fiduciary responsibilities at the company;
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Failure to replace management as appropriate; or
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Egregious actions related to the director(s) service on other boards that raise substantial doubt about his or her ability to effectively oversee
management and serve the best interests of shareholders at any company.
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RATIONALE: Director accountability and competence
have become issues of prime importance given the failings in oversight exposed by the global financial crisis. There is also concern over the environment in the boardrooms of certain markets, where past failures appear to be no impediment to
continued or new appointments at major companies and may not be part of the evaluation process at companies in considering whether an individual is, or continues to be, fit for the role and best able to serve shareholders interests.
Under exceptional circumstances that raise substantial doubt on a directors ability to serve as an effective monitor of management and
in the best interests of shareholders including past performance on other boards, we may consider a negative recommendation on directors.
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Other Board-Related Proposals
Classification/Declassification of the Board
Vote AGAINST
proposals to classify the board.
Vote FOR proposals to repeal classified boards and to elect all directors annually.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-110
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Independent Chairman (Separate Chairman/CEO)
Generally vote FOR shareholder proposals seeking separation of the offices of CEO and Chair if the company has a single executive occupying both positions.
RATIONALE: The separation of the positions of chairman and CEO in favour of an independent chairman of the board is superior to the lead director
concept. The positions of chairman and CEO are two distinct jobs with different job responsibilities. The chairman is the leader of the board of directors, which is responsible for selecting and replacing the CEO, setting executive pay, evaluating
managerial and company performance, and representing shareholder interests. The CEO, by contrast, is responsible for maintaining the day to day operations of the company and being the companys spokesperson. It therefore follows that one person
cannot fulfill both roles without conflict. An independent lead director may be an acceptable alternative as long as the lead director has clearly delineated and comprehensive duties including the full authority to call board meetings and approve
meeting materials and engage with shareholders. A counterbalancing lead director alternative must be accompanied by majority independence on the board and key committees, and the absence of any problematic governance practices.
Best practice as set out in National Policy 58-201 Corporate Governance Guidelines recommends that:
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The chair of the board should be an independent director or where this is not appropriate, an independent director should be appointed as lead
director.
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Majority of Independent Directors/Establishment of Committees
Vote FOR shareholder proposals asking that a majority or up to 2/3 of directors be independent unless:
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The board composition already meets the proposed threshold based on the ISS definition of independence.
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Vote FOR shareholder proposals asking that board audit, compensation, and/or nominating committees be composed exclusively of independent directors
unless:
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The boards committees already meet that standard.
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Majority Vote Standard for the Election of Directors
Vote FOR resolutions requesting that: (i) the board adopt a majority vote standard and director resignation policy for director elections or (ii) the company amend its bylaws to provide for
majority voting, whereby director nominees are elected by the affirmative vote of the majority of votes cast, unless:
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A majority voting policy is codified in the companys bylaws, corporate governance guidelines, or other governing documents prior to an election
to be considered, and;
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The company has adopted formal corporate governance principles that provide an adequate response to both new nominees as well as holdover
nominees (i.e. incumbent nominees who fail to receive 50% of votes cast).
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-111
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Proxy
ContestsVoting for Director Nominees in Contested Elections
Vote CASE-BY-CASE in contested elections taking into account:
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Long-term financial performance;
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Managements track record and compensation;
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Qualifications of director nominees (both slates); and
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Evaluation of what each side is offering shareholders.
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Overall Approach
When analyzing proxy contests, ISS focuses on two central questions:
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Have the dissidents met the burden of proving that board change is warranted? And, if so;
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Will the dissident nominees be more likely to affect positive change (i.e., increase shareholder value) versus the incumbent nominees?
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When a dissident seeks a majority of board seats, ISS will require from the dissident a well-reasoned and detailed business plan, including the
dissidents strategic initiatives, a transition plan and the identification of a qualified and credible new management team. ISS will then compare the detailed dissident plan against the incumbent plan and the dissident director nominees and
management team against the incumbent team in order to arrive at our vote recommendation.
When a dissident seeks a minority of board seats,
the burden of proof imposed on the dissident is lower. In such cases, ISS will not require from the dissident a detailed plan of action, nor is the dissident required to prove that its plan is preferable to the incumbent plan. Instead, the dissident
will be required to prove that board change is preferable to the status quo and that the dissident director slate will add value to board deliberations including by, among other factors, considering issues from a different viewpoint than the current
board members.
Reimbursing Proxy Solicitation Expenses
Vote CASE-BY-CASE taking into account:
Whether ISS recommends in favour of the dissidents, in
which case we may recommend approving the dissidents out of pocket expenses if they are successfully elected and the expenses are reasonable.
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3. Shareholder Rights & Defenses
Supermajority Vote Requirements
Vote AGAINST proposals to
require a supermajority shareholder vote at a level above that required by statute.
Vote FOR proposals to lower supermajority vote
requirements.
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B-112
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Cumulative Voting
In general, support cumulative voting. However there may be situations where such a structure may be detrimental to shareholder interests.
Generally vote AGAINST proposals to eliminate cumulative voting.
Generally vote FOR proposals to
restore or permit cumulative voting but exceptions may be made depending on the companys other governance provisions such as the adoption of a majority vote standard for the election of directors.
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Confidential Voting
Generally vote FOR shareholder proposals requesting that corporations adopt confidential voting, use independent vote tabulators and use independent inspectors of election, as long as:
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The proposal includes a provision for proxy contests as follows: In the case of a contested election, management should be permitted to request that
the dissident group honor its confidential voting policy. If the dissidents agree, the policy remains in place. If the dissidents will not agree, the confidential voting policy is waived for that particular vote.
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Generally vote FOR management proposals to adopt confidential voting.
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Appointment of Additional Directors Between Annual Meetings
Generally vote FOR these resolutions where:
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The company is incorporated under a statute (such as the CBCA) that permits removal of directors by simple majority vote;
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The number of directors to be appointed between meetings does not exceed one-third of the number of directors appointed at the previous annual meeting;
and
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Such appointments must be approved by shareholders at the annual meeting immediately following the date of their appointment.
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Poison Pills (Shareholder Rights Plans)
As required by the Toronto Stock Exchange, the adoption of a shareholder rights plan must be ratified by shareholders within six months of adoption.
Vote CASE-BY-CASE on management proposals to ratify a shareholder rights plan (poison pill) taking into account whether it conforms to new
generation rights plans and its scope is limited to the following two specific purposes:
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To give the board more time to find an alternative value enhancing transaction; and
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To ensure the equal treatment of all shareholders.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-113
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Vote AGAINST plans that go beyond these
purposes if:
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The plan gives discretion to the board to either:
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Determine whether actions by shareholders constitute a change in control;
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Amend material provisions without shareholder approval;
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Interpret other provisions;
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Redeem the rights or waive the plans application without a shareholder vote; or
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Prevent a bid from going to shareholders.
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The plan has any of the following characteristics:
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Unacceptable key definitions;
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Reference to Derivatives Contracts within the definition of Beneficial Owner;
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Permitted bid period greater than 60 days;
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Maximum triggering threshold set at less than 20% of outstanding shares;
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Does not permit partial bids;
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Includes a Shareholder Endorsed Insider Bid (SEIB) provision;
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Bidder must frequently update holdings;
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Requirement for a shareholder meeting to approve a bid; and
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Requirement that the bidder provide evidence of financing.
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Include an exemption for a permitted lock up agreement;
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Include clear exemptions for money managers, pension funds, mutual funds, trustees and custodians who are not making a takeover bid; and
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Exclude reference to voting agreements among shareholders.
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RATIONALE: The evolution of new generation shareholder rights plans in Canada has been the result of reshaping the early anti-takeover provision known as a poison pill into a
shareholder protection rights plan that serves only two legitimate purposes: (i) to increase the time period during which a Permitted Bid may remain outstanding to a maximum of 60 days in order to the give the board of directors of a target
company sufficient time over and above the current statutory 35 day limit, to find an alternative to a takeover bid that would increase shareholder value; and (ii) to ensure that all shareholders are treated equally in the event of a bid for
their company.
Elimination of board discretion to interpret the key elements of the plan was critical to this evolution. Definitions of
Acquiring Person, Beneficial Ownership, Affiliates, Associates and Acting Jointly or in Concert are the terms that set out the who, how, and when of a triggering event. These definitions in early poison pills contained repetitive, circular and
duplicative layering of similar terms which created confusion and made interpretation difficult. Directors were given broad discretion to interpret the terms of a rights plan to determine when it was triggered, in other words, whether a takeover bid
could proceed. This in turn, created enough uncertainty for
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-114
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bidders or potential purchasers, to effectively discourage non-board negotiated transactions. It can be seen how the early poison pill became synonymous with board and management entrenchment.
New generation rights plans have therefore been drafted to remove repetitive and duplicative elements along with language that
gives the board discretion to interpret the terms of the plan. Also absent from new generation plans are references to similar definitions in regulation. These definitions found in various regulations often contain repetitive elements
and references to other definitions in regulation that are unacceptable and not intended to serve the same purpose as those found in a new generation rights plan.
A number of other definitions are relevant to the key definitions mentioned above and are therefore equally scrutinized. Exemptions under the definition of Acquiring Person, for example, such as Exempt
Acquisitions and Pro Rata Acquisitions, are sometimes inappropriately drafted to permit acquisitions that should trigger a rights plan. In order for an acquisition to be pro rata, the definition must ensure that a person may not acquire a greater
percentage of the shares outstanding that the percentage owned immediately prior to the acquisition, by any means. It should also be noted that new generation rights plans are premised on the acquisition of common shares and ownership at
law or in equity, therefore references to the voting of securities or the extension of beneficial ownership to encompass derivative securities that may result in deemed beneficial ownership of securities that a person has no right to acquire, goes
beyond the acceptable purpose of a rights plan.
Equally important to the acceptability of a shareholder rights plan is the treatment of
institutional investors who have a fiduciary duty to carry out corporate governance activities in the best interests of the beneficial owners of the investments that they oversee. These institutional investors should not trigger a rights plan
through their investment and corporate governance activities for the accounts of others. The definition of Independent Shareholders should make absolutely clear these institutional investors acting in a fiduciary capacity for the accounts of others
are independent for purposes of approving a takeover bid or other similar transaction, as well as approving future amendments to the rights plan.
Probably one of the most important and most contentious definitions in a shareholder rights plan is that of a Permitted Bid. ISS guidelines provide that an acceptable Permitted Bid definition must permit
partial bids. Canadian takeover bid legislation is premised on the ability of shareholders to make the determination of the acceptability of any bid for their shares, partial or otherwise, provided that it complies with regulatory requirements. In
the event that a partial bid is accepted by shareholders, regulation requires that their shares be taken up on a pro rata basis. Shareholders of a company may welcome the addition of a significant new shareholder for a number of reasons.
Also unacceptable to the purpose of a rights plan is the inclusion of a Shareholder Endorsed Insider Bid (SEIB) provision which would allow
an Insider and parties acting jointly or in concert with an Insider an additional less rigorous avenue to proceed with a take-over bid without triggering the rights plan, in addition to making a Permitted Bid or proceeding with board
approval. The SEIB provision allows Insiders the ability to take advantage of a less stringent bid provision that is not offered to other bidders who must make a Permitted Bid or negotiate with the board for support.
Finally, a new generation rights plan must contain an exemption for lockup agreements and the definition of a permitted lockup agreement must
strike the proper balance so as not to discourage either (i) the potential for a bidder to lock up a significant shareholder and thus give some comfort of a certain degree of success, or (ii) the potential for competitive bids offering a
greater consideration and which would also necessitate a locked up person be able to withdraw the locked up shares from the first bid in order to support the higher competing bid.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-115
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New generation rights plans are limited
to achieving the two purposes identified here. They ensure that shareholders are treated equally in a control transaction by precluding creeping acquisitions or the acquisition of a control block through private agreements between a few large
shareholders; and they provide a reasonable time period to allow a corporations directors and management to develop an alternative to maximize shareholder value.
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4. Capital/Restructuring
Mergers and Corporate Restructurings
Overall Approach
For mergers and acquisitions, review and evaluate the merits and drawbacks of the proposed transaction, balancing the various and sometimes
countervailing factors including:
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Valuation
Is the value to be received by the target shareholders (or paid by the acquirer) reasonable? While the fairness opinion may
provide an initial starting point for assessing valuation reasonableness, emphasis is placed on the offer premium, market reaction and strategic rationale.
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Market Reaction
How has the market responded to the proposed deal? A negative market reaction should cause closer scrutiny of a deal.
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Strategic rationale
Does the deal make sense strategically? From where is value derived? Cost and revenue synergies should not be overly
aggressive or optimistic, but reasonably achievable. Management should also have a favourable track record of successful integration of historical acquisitions.
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Negotiations and process
Were the terms of the transaction negotiated at arms-length? Was the process fair and equitable? A fair process
helps to ensure the best price for shareholders. Significant negotiation wins can also signify the deal makers competency. The comprehensiveness of the sales process (e.g., full auction, partial auction, no auction) can also affect
shareholder value.
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Conflicts of interest
Are insiders benefiting from the transaction disproportionately and inappropriately as compared to non-insider
shareholders? As the result of potential conflicts, the directors and officers of the company may be more likely to vote to approve a merger than if they did not hold these interests. Consider whether these interests may have influenced these
directors and officers to support or recommend the merger. The CIC figure presented in the ISS Transaction Summary section of this report is an aggregate figure that can in certain cases be a misleading indicator of the true value
transfer from shareholders to insiders. Where such figure appears to be excessive, analyze the underlying assumptions to determine whether a potential conflict exists.
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Governance
Will the combined company have a better or worse governance profile than the current governance profiles of the respective
parties to the transaction? If the governance profile is to change for the worse, the burden is on the company to prove that other issues (such as valuation) outweigh any deterioration in governance.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-116
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Income
Trust Conversions
For an income trust, or in a broader sense, a Specified Investment Flow-Through Trust (SIFT), if it chooses to convert
into a corporation ahead of 2011, the expiry of the current tax benefit for SIFTs, ISS will recommend votes as follows:
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Generally AGAINST a trust conversion if the conversion itself will trigger any change-in-control payments or acceleration of options vesting;
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Generally AGAINST a trust conversion if bundled with an equity compensation plan resolution and the equity compensation plan itself does not warrant
shareholder support;
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Generally AGAINST an equity compensation plan proposal on the same agenda if the vesting of options is accelerated under the plan in connection with a
trust conversion.
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In addition, the authorization of newly created blank cheque preferred shares, particularly on an
unlimited basis, as part of the new capital structure of the resulting corporate entity is unacceptable from a corporate governance perspective and will generally result in a vote AGAINST the proposed conversion.
Otherwise, recommendations will be on a CASE-BY-CASE basis taking into account the following factors:
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Method of Conversion
Exchange Method by way of a statutory plan of arrangement; Distribution Method;
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Rationale of Conversion Ahead of Expiry of Tax Benefit
Pursuing growth rate higher than the rate limited by the normal growth
guideline; enhancing access to capital; overcoming the foreign ownership restriction; timing of the conversion versus availability of unused pool of tax credits (certain tax credits may offset the unused pool); superiority to other strategic
alternatives;
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Change of Annualized Payout Level
Comparison of 1-year and 3-year annualized distribution yield prior to the conversion and the proposed
annualized dividend yield;
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Equity Based Compensation Plan
Effect on the old plan (Vote AGAINST if the vesting of options is accelerated), features of the new plan;
whether or not bundled with the conversion as a single agenda item (a bundled agenda might trigger a vote AGAINST its approval);
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Change-in-Control
Whether or not the conversion will be treated as a change-in-control event (vote AGAINST if the conversion by itself will
trigger change-in-control payment); note both 4) and 5) are related to conflicts of interest;
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Cost of Implementing the Conversion
Legal fees, investment bank fees, etc., if disclosed;
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Market Reaction
Historical market performance dating back to October 30, 2006, the day before the announcement of changing tax rules;
market response to the conversion announcement;
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Corporate Governance
Examine the relative strength of the companys corporate governance going forward (from two-tier board structure
to one-tier board; equity capital from unit plus exchangeable shares to common shares);
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Dissent Rights
Whether or not unit holders are specifically granted dissent rights for the conversion.
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RATIONALE:
The criteria as set out here were developed based on the principle that early Trust conversion to a corporate structure results in a
loss of the tax benefit for SIFTs, and therefore must be justified on the basis of the trade-off between cost and benefit of the conversion. In addition, it is unacceptable from a corporate governance
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-117
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perspective for a Trust conversion to be treated as a change in control and trigger change in control payments. The successive equity compensation plan for the corporation should be considered
and voted on its own merits and should not be bundled with a trust conversion resolution.
The authorization of blank cheque preferred shares,
particularly on an unlimited basis, that may subordinate the rights and value of outstanding common shares is unsupportable from a corporate governance perspective. Board discretion to issue one or more classes of preferred shares for which the
terms and rights have not been defined and disclosed in order to afford shareholders the ability to give fully informed approval is anathema to the preservation of the full integrity and value of the ownership characteristics of issued and
outstanding common shares. Furthermore, issuances of blank cheque preferreds may be used as an anti-takeover mechanism at the discretion of the board by placing these shares in management friendly hands in the event of a takeover bid not supported
by management, the result of which may be to deny shareholders of the ability to consider a bid for their shares.
1. Income Trust Overview
An income trust, or in a broader sense, a Specified Investment Flow-Through Trust (SIFT), is an exchange traded equity-type investment that is
similar to common stock. By owning securities or assets of an underlying business (or businesses), an income trust is structured to distribute cash flows from those businesses to unit holders in a tax efficient manner. That is, by maintaining a
certain distribution ratio, a trust will pay little to no corporate income tax. Because of the focus on distributions, income trusts are usually based on mature businesses with steady cash flows.
2. SIFT Rules
On October 31, 2006 the
Canadian federal government announced a new tax regime for specified investment flow-through trusts (SIFTs) under which certain amounts distributed by SIFTs will be subject to tax at corporate income tax rates. SIFT trusts will not be able to deduct
distributions for tax purposes, and distributions will be treated as dividends to unit holders. The new tax is deferred until 2011 for SIFTs that were publicly traded on October 31, 2006 subject to normal growth guidelines which
permit SIFTs to grow their equity capital through new equity issuances by the greater of $50 million and a safe harbour amount of up to 100% of the SIFTs market cap as of October 31, 2006 over the four year transition period,
without triggering the new tax treatment.
As a result of the new tax treatment it was expected that SIFTs would want to convert into
corporations prior to 2011. On July 14, 2008, the government released the long-awaited draft amendments (the Conversion Amendments) to the Income Tax Act (Canada), allowing the conversion of certain income trusts into corporations
on a tax-deferred basis. The Conversion Amendments apply to conversions which occur after July 14, 2008 and before 2013, and are applicable to SIFT trusts, SIFT partnerships or REITs that are in existence at any time between the period of
October 31, 2006 and July 14, 2008 (a Qualifying SIFT). The Conversion Amendments were necessary to facilitate conversions prior to 2011 without unit holders or SIFTs having adverse tax implications.
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Reincorporation Proposals
Vote CASE-BY-CASE on proposals to change a companys jurisdiction of incorporation taking into account:
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Financial and corporate governance concerns, including: the reasons for reincorporating, a comparison of the governance provisions, and a comparison of
the jurisdictional laws.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-118
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Generally vote FOR reincorporation when:
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Positive financial factors outweigh negative governance implications; or
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Governance implications are positive.
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Generally vote AGAINST reincorporation if business implications are secondary to negative governance implications.
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By-Law Amendments
Generally vote FOR proposals to amend or replace by-laws if:
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The purpose of the amendment is to clarify ambiguity, reflect changes in corporate law, streamline years of amendments or other
housekeeping amendments, and
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The by-laws as amended will not result in any of the three unacceptable governance provisions set out in the following paragraph.
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Vote AGAINST a new by-law proposal, if any of the following conditions apply:
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The quorum for a meeting of shareholders is set below two persons holding 25% of the eligible vote (this may be reduced to no less than 10% in the case
of a small company that can demonstrate, based on publicly disclosed voting results, that it is unable to achieve a higher quorum and where there is no controlling shareholder );
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The quorum for a meeting of directors is less than 50% of the number of directors;
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The chair of the board has a casting vote in the event of a deadlock at a meeting of directors;
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The proposed Articles/By-laws raise other corporate governance concerns, such as granting blanket authority to the board with regard to future capital
authorizations or alteration of capital structure without shareholder approval.
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Capital Structure
Increases in Authorized Capital
Vote CASE-BY-CASE on proposals to increase the number of shares of common stock authorized for issuance. Generally vote FOR proposals to approve increased authorized capital if:
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A companys shares are in danger of being de-listed;
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A companys ability to continue to operate as a going concern is uncertain.
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Generally vote AGAINST proposals to approve unlimited capital authorization.
RATIONALE: Canadian jurisdictions generally, and most recently the British Columbia Corporations Act (BCCA), permit companies to have an unlimited authorized capital. ISS prefers to see companies with a
fixed maximum limit on authorized capital, with at least 30 % of the authorized stock issued and outstanding. Limited capital structures protect against excessive dilution and can be increased when needed with shareholder approval.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
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B-119
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Private
Placement Issuances
Vote CASE-BY-CASE on private placement issuances taking into account:
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Whether other resolutions are bundled with the issuance;
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The financial consequences for the company if the issuance is not approved.
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Generally vote FOR private placement proposals if:
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The issuance represents no more than 30 % of the companys outstanding shares;
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The use of the proceeds from the issuance is disclosed.
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RATIONALE: The Toronto Stock Exchange (TSX) requires shareholder approval for private placements:
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For an aggregate number of listed securities issuable greater than 25% of the number of securities of the issuer which are listed and outstanding, on a
non-diluted basis, prior to the date of closing of the transaction if the price per security is less than the market price; or
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That during any six month period are placed with insiders for listed securities or options, rights or other entitlements to listed securities greater
than 10% of the number of the issuers listed and outstanding securities, on a non-diluted basis, prior to the date of closing of the first private placement to an insider during the six month period.
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Allowable discounts for private placements not requiring shareholder approval are as follows:
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Market Price
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Maximum Discount
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$0.50 or less
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25
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%
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$0.51 to $2.00
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20
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%
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Above $2.00
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15
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%
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The TSX will allow the price per listed security for a particular transaction to be less than that specified above
provided that the listed issuer has received the approval of non-interested shareholders.
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Blank Cheque Preferred Stock
Generally vote AGAINST proposals to create unlimited blank cheque preferred shares or increase blank cheque preferred shares where:
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The shares carry unspecified rights, restrictions and terms;
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The company does not specify any specific purpose for the increase in such shares.
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Generally vote FOR proposals to establish these shares where both of the following apply:
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The company has stated in writing that the shares will not be used for anti-takeover purposes;
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The voting, conversion, and other rights, restrictions and terms of such stock are specified in the articles and are reasonable.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
|
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B-120
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Dual-class Stock
Generally vote AGAINST proposals to create a new class of common stock that will create a class of common shareholders with diminished voting rights.
The following is an exceptional set of circumstances under which we would generally support a dual class capital structure. Such a structure must meet
all
of the following criteria:
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It is required due to foreign ownership restrictions and financing is required to be done out of country;
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It is not designed to preserve the voting power of an insider or significant shareholder;
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The subordinate class may elect some board nominees;
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There is a sunset provision; and
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There is a coattail provisions that places a prohibition on any change in control transaction without approval of the subordinate class shareholders.
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Escrow Agreements
Generally vote AGAINST an amendment to an existing escrow agreement where the company is proposing to delete all performance-based release requirements in favour of the time-driven release requirements.
RATIONALE: On going public, certain insiders of smaller issuers must place a portion of their shares in escrow. The primary objective of
holding shares in escrow is to ensure that the key principals of a company continue their interest and involvement in the company for a reasonable period after public listing.
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5. Compensation
Executive Pay Evaluation
Evaluate executive pay and
practices, as well as certain aspects of outside director compensation on a CASE-BY-CASE basis.
Vote AGAINST management say on pay (MSOP)
proposals, WITHHOLD from compensation committee members (or in rare cases where the full board is deemed responsible, all directors including the CEO), and/or AGAINST an equity-based incentive plan proposal if:
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There is a misalignment between CEO pay and company performance (pay for performance);
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The company maintains problematic pay practices;
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The board exhibits poor communication and responsiveness to shareholders.
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Advisory Vote on Executive Compensation (Say-on-Pay) Management Proposals
Vote CASE-BY-CASE on management proposals for an advisory shareholder vote on executive compensation. Vote AGAINST these resolutions in cases where boards have failed to demonstrate good stewardship of
investors interests regarding executive compensation practices.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
|
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B-121
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The following five global principles
apply to all markets:
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Maintain appropriate pay-for-performance alignment with emphasis on long-term shareholder value: This principle encompasses overall executive pay
practices, which must be designed to attract, retain, and appropriately motivate the key employees who drive shareholder value creation over the long term. It will take into consideration, among other factors: the linkage between pay and
performance; the mix between fixed and variable pay; performance goals; and equity-based plan costs;
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Avoid arrangements that risk pay for failure: This principle addresses the use and appropriateness of long or indefinite contracts,
excessive severance packages, and guaranteed compensation;
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Maintain an independent and effective compensation committee: This principle promotes oversight of executive pay programs by directors with appropriate
skills, knowledge, experience, and a sound process for compensation decision-making (e.g., including access to independent expertise and advice when needed);
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Provide shareholders with clear, comprehensive compensation disclosures: This principle underscores the importance of informative and timely
disclosures that enable shareholders to evaluate executive pay practices fully and fairly;
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Avoid inappropriate pay to non-executive directors: This principle recognizes the interests of shareholders in ensuring that compensation to outside
directors does not compromise their independence and ability to make appropriate judgments in overseeing managers pay and performance. At the market level, it may incorporate a variety of generally accepted best practices.
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Voting Alternatives
In general, the management say on pay (MSOP) ballot item is the primary focus of voting on executive pay practicesdissatisfaction with compensation practices can be expressed by voting against MSOP
rather than withholding or voting against the compensation committee. However, if there is no MSOP on the ballot, then the negative vote will apply to members of the compensation committee. In addition, in egregious cases, or if the board fails to
respond to concerns raised by a prior MSOP proposal, then vote withhold or against compensation committee members (or, if the full board is deemed accountable, all directors). If the negative factors involve equity-based compensation, then vote
AGAINST an equity-based plan proposal presented for shareholder approval.
Pay for Performance:
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Rationale for determining compensation (e.g., why certain elements and pay targets are used, how they are used in relation to the companys
business strategy, and specific incentive plan goals, especially retrospective goals) and linkage of compensation to long-term performance;
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Evaluation of peer group benchmarking used to set target pay or award opportunities;
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Analysis of company performance and executive pay trends over time, taking into account ISS Pay for Performance policy;
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Mix of fixed versus variable and performance versus non-performance-based pay.
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Pay Practices:
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Assessment of compensation components included in the Problematic Pay Practices policy such as: perks, severance packages, employee loans, supplemental
executive pension plans, internal pay disparity and equity plan practices (including option backdating, repricing, option exchanges, or cancellations/surrenders and re-grants etc).;
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ISS 2012 Canadian TSX Proxy Voting Guidelines
|
|
B-122
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Existence of measures that discourage excessive risk taking which include but are not limited to: clawbacks, holdbacks, stock ownership requirements,
deferred compensation practices etc.
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Board Communications and Responsiveness:
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Clarity of disclosure (e.g. whether the companys Form 51-102F6 disclosure provides timely, accurate, clear information about compensation
practices in both tabular format and narrative discussion);
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Assessment of boards responsiveness to investor concerns on compensation issues (e.g., whether the company engaged with shareholders and / or
responded to majority-supported shareholder proposals relating to executive pay).
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Pay
for Performance
This policy will be applied at all S&P/TSX Composite Index Companies and for all Management Say On Pay Resolutions
Evaluate the alignment of the CEOs total compensation with company performance over time, focusing particularly on companies that have
underperformed their peers over a sustained period. From a shareholders perspective, performance is predominantly gauged by the companys share price performance over time. Even when financial or operational measures are used as the basis
for incentive awards, the achievement related to these measures should ultimately translate into superior shareholder returns in the long term.
Generally vote AGAINST an MSOP resolution and/or WITHHOLD votes from the Compensation Committee members and/or vote AGAINST an equity-based compensation
plan proposal if:
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There is a pay for performance disconnect between the CEOs total compensation and companys stock performance;
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The CEOs total compensation has increased from the prior year;
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If an equity-based plan is on the agenda, the main source of the increase (over half) is equity based, where the CEO is a participant of the equity
proposal.
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A pay for performance disconnect is defined as an increase in CEOs total compensation and the
companys one-year and three-year total shareholder returns are in the bottom half (50%) of its industry group (four-digit GICSGlobal Industry Classification Group). CEO total compensation is defined as the sum of base salary,
short-term (annual) and long-term non-equity incentives, grant date fair value of stock awards and options, target value of performance shares/units, pension value and All Other Compensation as reported in the Summary Compensation Table. Newly
appointed CEOs that have been with the company less than the past two complete fiscal years are exempted from the policy.
If a company falls
in the bottom half of its four-digit GICS group, further analysis of the Compensation Discussion and Analysis (CD&A) is required to better understand the various pay elements and whether they create or reinforce shareholder alignment. Other
considerations include:
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The CEOs pay relative to the companys TSR over a time horizon of at least five years. The most recent year-over-year increase or decrease
in pay remains a key consideration, but there will be additional emphasis on the long term trend of CEO total compensation relative to shareholder return;
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ISS 2012 Canadian TSX Proxy Voting Guidelines
|
|
B-123
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The mix of performance-based compensation relative to total compensation. In general, standard stock options or time-vested restricted stock are not
considered to be performance-based. If a company provides performance-based incentives to its executives, the company is highly encouraged to provide the complete disclosure of the performance measure and associated target goals (hurdle rates) so
that shareholders can assess the rigor of the performance program. The use of non-GAAP financial metrics also makes it very challenging for shareholders to ascertain the rigor of the program as shareholders often cannot tell the type of adjustments
being made and whether the adjustments were made consistently. Complete and transparent disclosure helps shareholders to better understand the companys pay for performance linkage.
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RATIONALE: This policy evaluates the alignment of the CEOs pay with performance over time, focusing particularly on companies that have
underperformed their peers over a sustained period. From a shareholders perspective, performance is predominantly gauged by the companys stock performance over time. Even when financial or operational measures are utilized in incentive
awards, the achievement related to these measures should ultimately translate into superior shareholder returns in the long term.
Problematic Pay Practices
Generally, vote AGAINST management advisory vote proposals, and/or WITHHOLD from compensation committee
members if the company has problematic compensation practices. In general, WITHHOLD on the entire slate if individual director elections are not permitted and the company has demonstrated problematic compensation practices. Also, generally vote
AGAINST equity plans if the plan is a vehicle for problematic compensation practices.
Generally vote based on the preponderance of
problematic elements; however, certain adverse practices may warrant Withhold or Against votes on a stand-alone basis in particularly egregious cases. The following practices, while not an exhaustive list, are examples of problematic compensation
practices that may warrant a vote against or withholding votes:
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Poor disclosure practices:
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General omission of timely information necessary to understand the rationale for compensation setting process and outcomes, or omission of material
contracts, agreements or shareholder disclosure documents;
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New CEO with overly generous new hire package:
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Excessive make whole provisions;
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Any of the problematic pay practices listed in this policy;
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Egregious employment contracts:
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Contracts containing multi-year guarantees for salary increases, bonuses and equity compensation;
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Interest free or low interest loans extended by the company to employees for the purpose of exercising options or acquiring equity to meet holding
requirements or as compensation;
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Excessive severance and/or change-in-control provisions:
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Inclusion of excessive change-in-control or severance payments, especially those with a multiple in excess of 2X cash pay (salary + bonus);
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|
ISS 2012 Canadian TSX Proxy Voting Guidelines
|
|
B-124
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Severance paid for a performance termination (i.e. due to the executives failure to perform job functions at the appropriate level);
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Employment or severance agreements that provide for modified single triggers, under which an executive may voluntarily leave following a change of
control for any reason and still receive the change-in-control severance package;
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Perquisites for former executives such as car allowance, personal use of corporate aircraft, or other inappropriate arrangements;
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Change-in-control payouts without loss of job or substantial diminution of job duties (single-triggered);
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Abnormally large bonus payouts without justifiable performance linkage or proper disclosure:
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Performance metrics that are changed, canceled, or replaced during the performance period without adequate explanation of the action and the link to
performance;
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Egregious pension/SERP (supplemental executive retirement plan) payouts:
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Inclusion of performance-based equity awards in the pension calculation;
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Inclusion of target (unearned) or excessive bonus amounts in the pension calculation;
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Addition of extra years service credited without compelling rationale;
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No absolute limit on SERP annual pension benefits (any limit should ideally be expressed in $ terms);
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No reduction in benefits on a pro-rata basis in the case of early retirement;
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Overly generous cost and/or reimbursement of taxes for personal use of corporate aircraft, personal security systems maintenance and/or installation,
car allowances, and/or other excessive arrangements relative to base salary;
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Payment of dividends on performance awards:
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Performance award grants for which dividends are paid during the period before the performance criteria or goals have been achieved, and therefore not
yet earned;
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Problematic option granting practices:
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Backdating options, or retroactively setting a stock options exercise price lower than the prevailing market value at the grant date;
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Springloading options, or timing the grant of options;
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Cancellation and subsequent re-grant of options;
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Internal Pay Disparity:
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Excessive differential between CEO total pay and that of next highest-paid named executive officer (NEO);
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Absence of pay practices that discourage excessive risk taking:
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These provisions include but are not limited to: clawbacks, holdbacks, stock ownership requirements, deferred bonus and equity award compensation
practices, etc;
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|
ISS 2012 Canadian TSX Proxy Voting Guidelines
|
|
B-125
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Financial institutions will be expected to have adopted or at least addressed the provisions listed above in accordance with the Financial Stability
Boards (FSB) Compensation Practices and standards for financial companies;
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Other excessive compensation payouts or problematic pay practices at the company.
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RATIONALE
:
Shareholders are not generally permitted to vote on provisions such as change-in-control provisions or the ability of an issuer to
extend loans to employees to exercise stock options, for example, when reviewing equity based compensation plan proposals. Nor do shareholders in Canada have the ability to approve employment agreements, severance agreements, or pensions, however,
these types of provisions, agreements, and contractual obligations continue to raise shareholder concerns. Therefore, ISS will review disclosure related to the various components of executive compensation and may recommend withholding from the
compensation committee or against an equity plan proposal if compensation practices are unacceptable from a corporate governance perspective.
Board Communications and Responsiveness
Consider the following on a Case-by-Case basis when evaluating ballot items related to executive pay:
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Poor disclosure practices, including: insufficient disclosure to explain the pay setting process for the CEO and how CEO pay is linked to company
performance and shareholder return; lack of disclosure of performance metrics and their impact on incentive payouts; no disclosure of rationale related to the use of board discretion when compensation is increased or performance criteria or metrics
are changed resulting in greater amounts paid than that supported by previously established goals.
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Boards responsiveness to investor input and engagement on compensation issues, for example: failure to respond to majority-supported shareholder
proposals on executive pay topics, or failure to respond to concerns raised in connection with significant opposition to MSOP proposals.
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Equity Compensation Plans
Vote CASE-BY-CASE on equity-based compensation plans. Vote AGAINST the plan if any of the following factors applies:
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Cost of Equity Plans
: The total cost of the companys equity plans is unreasonable;
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Dilution and Burn Rate
: Dilution and burn rate are unreasonable, where the cost of the plan cannot be calculated due to lack of relevant
historical data.
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Plan Amendment Provisions
: The provisions do not meet ISS guidelines as set out in this section.
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Non-Employee Director Participation
: Participation of directors is discretionary or unreasonable.
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Pay for performance
: There is a disconnect between CEO pay and the companys performance.
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Repricing Stock Options
: The plan expressly permits the repricing of stock options without shareholder approval and the company has repriced
options within the past three years.
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Problematic Pay Practices
: The plan is a vehicle for problematic pay practices.
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Each of these factors is examined below.
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|
ISS 2012 Canadian TSX Proxy Voting Guidelines
|
|
B-126
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Cost of
Equity Plans
Generally vote AGAINST equity plans if the cost is unreasonable.
RATIONALE: Section 613 of the TSX Company Manual, requires shareholder approval for equity-based compensation arrangements under which securities listed on the TSX may be issued from treasury. Such
approval is also required for equity-based plans that provide that awards issued may be settled either in treasury shares or cash. Cash only settled arrangements or those which are only funded by securities purchased on the secondary market are not
subject to shareholder approval.
In addition, certain equity awards made outside of an equity plan, stock purchase plans using treasury
shares where financial assistance or share matching is provided, and security purchases from treasury where financial assistance is provided, are also subject to shareholder approval.
Our methodology for reviewing share-based compensation plans primarily focuses on the transfer of shareholder wealth (the dollar cost of share plans to shareholders) instead of simply focusing on
dilution. Using information disclosed by the company and assuming the broadest definition of plan terms, ISS will value equity-based awards using a binomial option pricing model. ISS will include in its analyses an estimated dollar cost for the
proposed plan and all continuing plans. This total cost will be expressed as a percentage of market value (i.e. 200-day average share price times common shares outstanding). This result is tested for reasonableness by comparing the figure to an
allowable cap derived from compensation plan costs of the top performing quartile of peer companies in each industry group (using Global Industry Classification Standard GICS codes). Benchmark SVT levels for each industry are established based on
these top performers historic SVT. Regression analyses are run on 44 different variables including company size, market-based performance metrics, and accounting-based performance metrics, for each industry group to identify the variables most
strongly correlated to SVT. The benchmark industry SVT level is then adjusted upwards or downwards for the specific company by incorporating the company-specific performance measures, size and cash compensation into the industry cap equations to
arrive at the companys allowable cap.
Shareholder Value Transfer is reasonable if it falls below the company-specific allowable cap.
Volatility and Stock Price Assumptions in Equity Plan Proposals (SVT)
For the Dec. 1, 2009 and future quarterly data downloads, ISS will calculate the 200-day volatility and the 200-day average stock price for the shareholder value transfer policy.
Dilution and Burn Rate Assessment
In cases where the cost of the plan cannot be calculated using the binomial model due to lack of historic data for a newly created or merged corporate entity, ISS will apply a dilution and burn rate
analysis.
Generally vote AGAINST the proposed equity plan if:
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Dilution under all company plans would be more than 10% of the outstanding shares on a non-diluted basis, OR
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The historic burn rate for all company plans has been more than 2% per year (generally calculated over most recent 3-year period). If equity has
been granted as part of the resolution subject to shareholder approval and the grants made exceed 2% of the outstanding shares a vote AGAINST is warranted.
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|
ISS 2012 Canadian TSX Proxy Voting Guidelines
|
|
B-127
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Plan
Amendment Provisions
Generally vote AGAINST the approval of proposed Amendment Procedures that do not require shareholder approval for the
following types of amendments under any security based compensation arrangement, whether or not such approval is required under current regulatory rules:
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Any increase in the number of shares reserved for issuance under a plan or plan maximum;
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Any reduction in exercise price or cancellation and reissue of options or other entitlements;
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Any amendment that extends the term of options beyond the original expiry.
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Amendments to eligible participants that may permit the introduction or reintroduction of non-employee directors on a discretionary basis or amendments
that increase limits previously imposed on non-employee director participation.
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Any amendment which would permit options granted under the Plan to be transferable or assignable other than for normal estate settlement purposes.
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Amendments to the plan amendment provisions.
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To clarify application of the above criteria, all items will apply to all equity-based compensation arrangements under which treasury shares are reserved for grants of, for example: restricted stock,
restricted share units, or deferred share units, except those items that specifically refer to option grants.
RATIONALE: In response to the
rule changes affected by the Toronto Stock Exchange (TSX) related to Part IV, Subsection 613 of the TSX Company Manual and Staff Notices #2004-0002, and #2006-0001 which came into effect in 2007, ISS has revised its policy with regard to Equity
Compensation Plan Amendment Procedures. This policy addresses the removal by the TSX of previously established requirements for shareholder approval of certain types of amendments to Security-Based Compensation Arrangements of its listed issuers.
For the purposes of the rule change, security-based compensation arrangements include: stock option plans for the benefit of employees, insiders and service providers; individual stock options granted to any of these specified parties outside of a
plan; stock purchase plans where the issuer provides financial assistance or where the employee contribution is matched in whole or in part by an issuer funded contribution; stock appreciation rights involving the issuance of treasury shares; any
other compensation or incentive mechanism involving the issuance or potential issuance of securities of the listed issuer; security purchases from treasury by an employee, insider or service provider which is financially assisted by the issuer in
any manner. Issuers had until June 30, 2007 to adopt the proper Amendment Procedure in their Plans. After such date, issuers who have general amendment provisions in their Plans are no longer able to make any amendments to their
Plans without security holder approval, including amendments considered to be of a housekeeping nature until they have put a shareholder approved detailed Plan Amendment Provision in place.
According to the TSX Guide to Security-Based Compensation Arrangements, the following amendments will continue to be subject to security holder approval
according to TSX rules notwithstanding the amendment provisions included in the plan:
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Any increase in the number of shares reserved for issuance under a plan or plan maximum;
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Any reduction in exercise price of options or other entitlements which benefits an insider
9
;
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9
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Security holder approval, excluding the votes of securities held by insiders benefiting from the amendment, is required for a reduction in the exercise
price, purchase price, or an extension of the term of options or similar securities held by insiders. If an issuer cancels options or similar securities held by insiders and then reissues those securities under different terms, the TSX will consider
this an amendment to those securities and will require security holder approval, unless the regrant occurs at least 3 months after the related cancellation. Staff Notice #2005-0001, Section 613 Security Based Compensation Arrangements,
S.613(h)(iii) Amendments to Insider Securities.
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ISS 2012 Canadian TSX Proxy Voting Guidelines
|
|
B-128
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Any amendment that extends the term of options beyond the original expiry and that benefits an insider of the issuer;
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Changes to insider participation limits which result in the security holder approval to be required on a disinterested basis;
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Amendment provisions granting additional powers to the board of directors to amend the plan or entitlements without security holder approval.
|
The TSX has further clarified that shareholder approval is required for any amendment to the Plan Amendment Provision.
In addition, the TSX requires that the exercise price for any stock option granted under a security based compensation arrangement or
otherwise, must not be lower than the market price of the securities at the time the option is granted.
Any proposal to increase the maximum
number of shares reserved under a plan requires specific shareholder approval for the increase even if the plan includes a shareholder-approved general amendment procedure permitting increases to such maximum numbers.
Sections 613(d) and (g) set out a list of disclosure requirements in respect of materials that must be provided to security holders in meeting
materials issued prior to a meeting at which the approval of any security based compensation arrangement is requested. The disclosure requirements include annual disclosure by listed issuers in their information circular or other annual disclosure
document distributed to all security holders, the terms of any security based compensation arrangement as well as any amendments that were adopted in the most recently completed fiscal year, including whether or not security holder approval was
obtained for the amendment. Staff Notice #2005-0001 goes on to clarify that such disclosure must be as of the date of the information circular containing the relevant disclosure and that issuers must update disclosure for the most recently completed
fiscal year end to include grants, exercises, amendments, etc. which may occur after the fiscal year end is completed, but prior to the filing of the information circular.
ISS has reiterated the need for shareholder approval for the amendments that currently still require shareholder approval by the TSX due to the ability of the TSX to change or eliminate these requirements
at any time in future which we believe would not be in the best interests of shareholders or consistent with institutional investor proxy voting guidelines. Note however that from a corporate governance viewpoint, ISS does not support re-pricing of
any outstanding options and does not limit this policy to only those options held by insiders. ISS has for many years recommended against any re-pricing of outstanding options. Our reasons are based on the original purpose of stock options as
at-risk, incentive compensation that is meant to align the interests of option-holders with those of shareholders. The incentive value of stock options is diminished when the exercise price of out-of-the-money options can be adjusted downwards, and
is not supportable when shareholders must suffer the consequences of a downturn in share price.
Discretionary participation by non-employee
directors in equity compensation plans is unacceptable from a corporate governance and accountability viewpoint because administrators of the plan should not have the unrestricted ability to issue awards to themselves due to concerns of
self-dealing. Directors who are able to grant themselves equity awards without limit could find their independence compromised. Therefore, the inclusion of non-employee directors in management equity based compensation plans, while not preferable,
must at a minimum be subject to shareholder-approved limits. Issuer discretion to change eligible participants may result in discretionary director participation. For clarification purposes, in keeping with ISS policy regarding
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acceptable limits on non-employee director participation, if directors are included in an employee equity compensation plan according to a shareholder approved limit, then any amendment that
would remove or increase such limit should be approved by shareholders.
The ability of plan participants to assign options by means of Option
Transfer Programs or any other similar program which results in option holders receiving value for underwater options when shareholders must suffer the consequences of declining share prices does not align the interests of option holders with those
of shareholders and removes the intended incentive to increase share price which was originally approved by shareholders.
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Non-Employee Director Participation
Vote AGAINST discretionary non-employee director participation in management equity compensation plans.
RATIONALE: Due to the continuing use of options in compensation plans in Canada, we have not opposed the use of options for outside directors per se, but have tried to address potential governance
concerns by ensuring a reasonable limit on grants to the independent non-employee directors who are charged with overseeing not only a companys compensation scheme but also its corporate governance and long-term sustainability. To this end,
ISS policy established an acceptable range for aggregate non-employee director option grants of 0.25% to 1% of the outstanding shares. A company was expected to fall within this range based on its size and stage of development, so that larger, more
mature companies would be limited to something closer to 0.25%, and smaller companies with less cash and much lower share prices would be at the upper end of the range and have a larger pool of shares, options typically, from which to draw. This
range was originally established based on an underlying policy that an upper limit of $1 million worth of stock acquired by means of option grants for each director over the life of a typical 10-year plan seemed reasonable to prevent misalignment of
purpose.
Director Limit Considerations
Generally vote AGAINST an equity compensation plan proposal which provides that: (i) non-employee director participation exceeds our established 1% director pool limit, or (ii) non-employee
director participation exceeds a $100,000
per director per year
maximum within the 0.25% to 1% of the outstanding shares range, taking into account:
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The overall mix of pay elements (cash vs. equity)
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The type of equity awards granted (deferred stock units, restricted stock, stock options)
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Director share holding requirements and how they are achieved (stock granted outright until a target is met vs. some skin in the game in
the form of directors taking DSUs in lieu of cash fees)
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Rigor of mandatory and disclosed vesting requirements (i.e., vest when director leaves the board)
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Overall company performance as well as director pay levels vs. peers.
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In the absence of best in class director pay practices (as detailed below), generally vote AGAINST an equity plan proposal if the $100,000 per director per year equity award maximum is
exceeded.
Generally vote AGAINST individual equity grants to non-employee directors outside of an equity compensation plan if:
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The directors annual grant would exceed the above per director maximum other than a reasonable one-time grant upon joining the board.
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RATIONALE: ISS will assess the
non-employee director component (or reserve) of equity-based compensation plans based on the ISS compensation model (binomial) award value that is used for employee compensation purposes. This will be consistent with our methodology for establishing
the value of awards for employee participants and the plan generally.
The proposed maximum for non-employee director equity grants including
options will then factor in: the difference between options and full value awards (i.e., time-vesting restricted stock); option terms (5, 7 or 10 years usually); share price volatility; expected forfeiture rate; and any other criteria factored into
a binomial type evaluation.
Using the binomial equity award value, we have established a maximum non-employee director participation limit of
the lesser of: (i) an aggregate reserve of 1% of the shares outstanding for all non-executive directors; and (ii) an annual equity award value of $100,000 per director. Equity award refers to options, restricted stock, deferred stock units
or any other equity grant made outside of or under an equity compensation plan, other than equity granted or taken in lieu of cash fees.
However, there may be director pay structures that have addressed institutional investor concerns so that directors truly have substantial at
risk pay that achieves alignment of directors interests closely with those of shareholders, therefore some limited flexibility in implementing this guideline is necessary for those best in class director pay packages.
Best in Class Non-Employee Director Pay would require, at a minimum:
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Mandatory director shareholding requirements met by directors giving up cash for shares;
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Elimination of stock options (including SARs);
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Use of deferred share units, all or a portion of which would be taken in lieu of annual cash retainers;
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Minimal use of restricted stock or restricted share units and ONLY if mandatory vesting of at least three years or ideally until retirement from the
board;
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Reasonable limit on non-employee director DSUs or RSUs that is fixed, priced at market and shareholder approved;
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No board discretion to amend the material terms or conditions of shareholder approved plans;
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Complete and clear disclosure of all elements of director pay and discussion of the rationale supporting the current director pay structure.
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This list is not all-inclusive and other considerations such as overall corporate governance structure and performance may
factor into our policy application.
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Repricing Options
Generally vote AGAINST an equity-based compensation plan proposal if the plan expressly permits the repricing of options without shareholder approval and the company has repriced options within the past
three years.
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Repricing
Proposals
Generally vote AGAINST proposals to re-price outstanding options, unless:
Repricing is part of a broader plan amendment that substantially improves the plan and provided that the following conditions are met:
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A value-for-value exchange is proposed;
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The five top paid officers are excluded;
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Options exercised do not go back into the plan OR the company commits to an annual burn rate cap.
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RATIONALE: Security Based Compensation Arrangements Section 613(h)(iii) of the TSX Company Manual requires security holder approval (excluding the
votes of securities held directly or indirectly by insiders benefiting from the amendment) for a reduction in the exercise price or purchase price or an extension of the term of an award under a security based compensation arrangement benefiting an
insider of the issuer notwithstanding that the compensation plan may have been approved by security holders.
ISS has long opposed option
repricing and believes that any proposal to reduce the price of outstanding options including those held by non-insiders, should be approved by shareholders before being implemented (see discussion under Plan Amendment Provisions). Market
deterioration, in and of itself, is not an acceptable reason for companies to reprice stock options and/or reset goals under performance plans.
The extension of option terms is also unacceptable. Options are not meant to be a no-risk proposition and may lose their incentive value if the term can
be extended when the share price dips below the exercise price. Shareholders approve option grants on the basis that recipients have a finite period during which to increase shareholder value, typically five to ten years. As a company would not
shorten the term of an option to reign in compensation during profitable bull market runs, it is not expected to extend the term during a market downturn when shareholders must suffer a decrease in shareholder value.
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Other Compensation Plans
Employee Stock Purchase Plans (ESPPs, ESOPs)
Generally vote
FOR broadly based (preferably all employees of the company with the exclusion of individuals with 5% or more beneficial ownership of the company) employee stock purchase plans where the following apply:
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Reasonable limit on employee contribution (may be expressed as a fixed dollar amount or as a percentage of base salary excluding bonus, commissions and
special compensation);
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Employer contribution of up to 25% of employee contribution and no purchase price discount or employer contribution of more than 25% of employee
contribution and SVT cost of the companys equity plans is within the allowable cap for the company;
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Purchase price is at least 80% of fair market value with no employer contribution;
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Potential dilution together with all other equity-based plans is ten percent of outstanding common shares or less; and
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Plan Amendment Provision requires shareholder approval for amendments to:
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the number of shares reserved for the plan;
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the allowable purchase price discount;
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the employer matching contribution amount.
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Treasury funded ESPPs, as well as market purchase funded ESPPs requesting shareholder approval, will be considered to be incentive based compensation if the employer match is greater than 25% of the
employee contribution. In this case, the plan will be run through the ISS compensation model to assess the Shareholder Value Transfer (SVT) cost of the plan together with the companys other equity-based compensation plans.
Eligibility and administration are also key factors in determining the acceptability of an ESPP/ESOP plan.
ISS will also take into account other compensation and benefit programs, in particular pensions.
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Deferred Share Unit Plans
Generally vote FOR Deferred Compensation Plans if:
Potential dilution together with all other
equity-based compensation is ten percent of the outstanding common shares or less.
Other elements of director compensation to evaluate in
conjunction with deferred share units include:
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Director stock ownership guidelines of a minimum of three times annual cash retainer
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Vesting schedule or mandatory deferral period which requires that shares in payment of deferred units may not be paid out until the end of three years
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The mix of remuneration between cash and equity
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Other forms of equity-based compensation, i.e. stock options, restricted stock.
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RATIONALE: Deferrred compensation plans generally encourage a sense of ownership in the company. These types of deferred compensation arrangements are
usually designed to compensate outside directors by allowing them the opportunity to take all or a portion of their annual retainer in the form of deferred units, the payment of which is postponed to some future time, typically retirement or
termination of directorship and may be in cash and/or stock.
A DSU plan only requires shareholder approval if it reserves treasury shares.
However, a number of companies continue to request shareholder approval for DSU plans funded by shares purchased in the open market. This type of plan will be evaluated on a qualitative basis in the same manner that ESPPs (see above) are evaluated.
Eligibility and administration are key factors in determining the acceptability of such plans.
Treasury Funded Plans
Deferred share units awarded under any equity compensation plan where: i) the authorization of treasury shares for issuance is in payment of the DSUs; and
ii) the DSU grants are not in-lieu of cash, would be evaluated by running the compensation model.
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Shareholder Proposals on Compensation
Vote CASE-BY-CASE basis for shareholder proposals targeting executive and director pay, taking into account:
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The target companys performance, absolute and relative pay levels as well as the wording of the proposal itself.
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Generally vote FOR shareholder proposals requesting that the exercise of some, but not all stock options be tied to the achievement of performance
hurdles.
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Shareholder Advisory Vote Proposals
Generally vote FOR shareholder proposals requesting the adoption of an advisory shareholder vote to ratify the report of the compensation committee.
Generally vote AGAINST shareholder proposals requesting a binding vote on executive or director compensation as being overly prescriptive and which may
lead to shareholder micro-management of compensation issues that are more appropriately within the purview of the compensation committee of the board of directors.
RATIONALE
:
Based on the experience of other global markets where advisory votes are permitted, the consensus view is that advisory votes serve as a catalyst for dialogue between investors and
public issuers on questionable or contentious compensation practices and can lead to a higher level of board accountability, a stronger link between pay and performance, significantly improved disclosure, and in some cases a noticed deceleration in
the rate of increase in executive compensation overall.
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Supplemental Executive Retirement Plans (SERPS) Proposals
Generally vote AGAINST shareholder proposals requesting the exclusion of bonus amounts and extra service credits to determine SERP payouts, unless the
companys SERP disclosure includes the following problematic pay practices:
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Inclusion of equity-based compensation in the pension calculation;
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Inclusion of target (unearned) or excessive bonus amounts in the pension calculation;
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Addition of extra years service credited in other than exceptional circumstances and without compelling rationale;
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No absolute limit on SERP annual pension benefits (ideally expressed in $ terms);
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No reduction in benefits on a pro-rata basis in the case of early retirement.
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In addition, consideration will also be given to the extent to which executive compensation is performance driven and at risk, as well as
whether bonus payouts can exceed 100% of base salary.
Rationale: The inclusion of bonus and unlimited incentive compensation amounts along
with base salary as the basis for calculating supplemental pension benefits is generally viewed as unacceptable market practice. Proposals that aim to limit excessive pension payments for executives are laudable. The inclusion of variable
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compensation or other enhancements under SERP provisions can significantly drive up the cost of such plans, a cost that is absorbed by the company and its shareholders.
However, we appreciate the need for Canadian companies to attract and retain key executives in an increasingly competitive global economy and believe
that a broader review of total compensation and performance are necessary in evaluating any compensation related proposal. Investor pressure to structure executive compensation so that the majority is at risk has driven down base salary
and therefore it may be reasonable to include short term cash bonus amounts in the bonus calculation. Therefore, ISS will assess limits imposed on extra service credits and the overall mix of guaranteed (salary) and at risk (performance driven
incentive compensation) executive compensation, as well as the size of potential cash bonus amounts, when determining vote recommendations on SERP shareholder proposals asking for elimination of these elements in SERP calculations. Given the
conservative general market practice in this regard, support for such proposals should be limited to those companies that exceed standard market practice thus qualifying as problematic pay practices as outlined above.
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6. Social and Environmental Issues
Generally vote CASE-BY-CASE taking the following into consideration:
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Whether adoption of the proposal is likely to enhance or protect shareholder value;
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Whether the information requested relates to a meaningful percentage of the companys business as measured by sales, assets and earnings;
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The degree to which the companys stated position on the issue raised, or lack thereof, could affect its reputation or sales, or leave it
vulnerable to boycott or selective purchasing, or investor, regulatory or legal sanctions;
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Whether the issues presented are more appropriately/effectively dealt with through government regulation or policy changes;
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Whether the company has already responded in an appropriate manner to the request embodied in the proposal;
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Whether the companys analysis and voting recommendation to shareholders are persuasive;
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Whether the proposal itself is well framed and the cost of preparing a report, if requested, is reasonable;
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General industry standards for dealing with the issue taking into consideration the impact of globalization and acceptable standards for transnational
corporations;
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Whether implementation of the proposal would achieve the objectives sought in the proposal;
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Whether the subject of the proposal is best left to the discretion of the board;
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Whether the requested information is available to shareholders from the company or other publicly available sources;
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Whether providing this information would reveal proprietary or confidential information that would place the company at a competitive disadvantage.
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RATIONALE: These issues cover a wide range of topics, including consumer and product safety, environment and energy,
general corporate issues, labor standards and human rights, HIV/AIDS and other health related issues, military business, and workplace diversity.
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In evaluating any shareholder proposal,
ISS seeks to determine if a shareholder resolution is reasonable in both scope and approach to a specific issue. In most cases, our social and environmental issue voting recommendations will not seek to establish or enforce a best
practice approach but rather we will establish industry standards to determine if the company falls outside of the accepted norms (thus creating risk exposure), evaluate the importance of the issue to the companys core business, and
evaluate the potential for impact on share value.
In evaluating these types of proposals, ISS examines whether the issue should be addressed
on a company-specific basis. Many social and environmental proposals are beyond the scope of any one company and would be more properly or effectively addressed by government and/or broader regulatory action. While a wide variety of factors goes
into each analysis, the overall principal guiding all vote recommendations focuses on how the proposal may enhance the economic value of the company or conversely how it may reduce risk exposure that has the potential to substantially negatively
impact shareholder value in either the short-term or long-term. Proposals seeking reasonable disclosure on corporate responsibility issues will be supported unless current disclosure in the targeted area by the company is already satisfactory.
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Disclosure/Disclaimer
This document and all of the information contained in it, including without limitation all text, data, graphs, and charts (collectively, the Information) is the property of Institutional
Shareholder Services Inc. (ISS), its subsidiaries, or, in some cases third party suppliers.
The Information has not been submitted to, nor
received approval from, the United States Securities and Exchange Commission or any other regulatory body. None of the Information constitutes an offer to sell (or a solicitation of an offer to buy), or a promotion or recommendation of, any
security, financial product or other investment vehicle or any trading strategy, and ISS does not endorse, approve, or otherwise express any opinion regarding any issuer, securities, financial products or instruments or trading strategies.
The user of the Information assumes the entire risk of any use it may make or permit to be made of the Information.
ISS MAKES NO EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS WITH RESPECT TO THE INFORMATION AND EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING,
WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS, NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY, AND FITNESS FOR A PARTICULAR PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION.
Without limiting any of the foregoing and to the maximum extent permitted by law, in no event shall ISS have any liability regarding any of the
Information for any direct, indirect, special, punitive, consequential (including lost profits), or any other damages even if notified of the possibility of such damages. The foregoing shall not exclude or limit any liability that may not by
applicable law be excluded or limited.
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2012 European Proxy Voting Summary Guidelines
December 19, 2011
Institutional Shareholder
Services Inc.
Copyright
©
2011 by ISS
www.issgovernance.com
B-137
ISS 2012 European
Proxy Voting Summary Guidelines
Effective for Meetings on or after Feb. 1, 2012
Published Dec. 19, 2011
The
following is a condensed version of the proxy voting recommendations contained in ISS European Proxy Voting Manual. Note that markets covered in this document exclude Eastern Europe. The voting policy applied by ISS in the U.K. is that of the
National Association of Pension Funds (NAPF) and an update to that policy will be issued by the NAPF.
Table of Contents
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INTRODUCTION
The primary purpose of a public corporation is to create sustainable value for its shareowners. To that end, ISS designs its proxy voting guidelines to
enhance shareholders long-term economic interests. ISS Benchmark proxy voting guidelines serve as a tool to assist institutional investors in meeting their fiduciary requirements with respect to voting by promoting shareholder value
creation and risk mitigation at their portfolio firms.
ISS reviews and updates its proxy voting guidelines each year, taking into account
emerging issues and trends, the evolution of market standards, regulatory changes, and feedback provided by ISS institutional clients.
ISS robust and transparent
policy formulation process
includes an exhaustive review of relevant empirical studies and other factual data, an
annual
policy survey
of institutional clients and corporate issuers, policy roundtables with a wide range of industry constituents, and an open
comment period
on draft policy changes. ISS also conducts internal research to validate
assumptions and policy positions.
The Benchmark Policy Guidelines consider market-specific recommended best practices, transparency, and
disclosure when addressing issues such as board structure, director accountability, corporate governance standards, executive compensation, shareholder rights, corporate transactions, and social/environmental issues.
ISS policy guidelines require the consideration of company-specific circumstances. When issuing a vote recommendation on a proposal, ISS considers
historical operating and investment performance, company disclosure (and proponent/dissident disclosure, if applicable), the companys governance structure and historical practices, and its industry.
In applying these policies, ISS often engages with public issuers, shareholders, activists, and other stakeholders to seek additional information and to
gain insight and context in order to provide our clients with informed vote recommendations. This engagement process enhances dialogue and promotes a higher level of understanding between investors and the companies in which they invest.
In formulating proxy voting policies, ISS assesses the potential costs and benefits of the adoption or rejection of the underlying ballot items. Where
the economic impact of a ballot item is not apparent and may involve trade-offs, the guidelines direct analysts to consider the economic consequences as well as potential risks to shareholders of approval.
This document presents ISS Benchmark European Corporate Governance Policies. The document, along with other policy documents, is available on our
Web site under the
Policy Gateway
. If you have any questions, please contact
ISS_EU-research@issgovernance.com
.
These policies
will be effective for meetings on or after Feb. 1, 2012.
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1.
OPERATIONAL ITEMS
Financial Results/Director and Auditor Reports
Vote FOR approval of financial statements and director and auditor reports, unless:
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There are concerns about the accounts presented or audit procedures used; or
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The company is not responsive to shareholder questions about specific items that should be publicly disclosed.
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Appointment of Auditors and Auditor Fees
Vote FOR the (re)election of auditors and/or proposals authorizing the board to fix auditor fees, unless:
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There are serious concerns about the procedures used by the auditor;
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There is reason to believe that the auditor has rendered an opinion that is neither accurate nor indicative of the companys financial position;
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External auditors have previously served the company in an executive capacity or can otherwise be considered affiliated with the company;
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Name of the proposed auditors has not been published;
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The auditors are being changed without explanation; or
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Fees for non-audit services exceed standard annual audit-related fees (only applies to companies on the MSCI EAFE index and/or listed on any country
main index).
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In circumstances where fees for non-audit services include fees related to significant one-time capital
structure events (initial public offerings, bankruptcy emergencies, and spinoffs) and the company makes public disclosure of the amount and nature of those fees, which are an exception to the standard non-audit fee category, then such
fees may be excluded from the non-audit fees considered in determining the ratio of non-audit to audit fees.
For concerns related to the
audit procedures, independence of auditors, and/or name of auditors, ISS may recommend AGAINST the auditors (re)election. For concerns related to fees paid to the auditors, ISS may recommend AGAINST remuneration of auditors if this is a
separate voting item; otherwise ISS may recommend AGAINST the auditor election.
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Appointment of Internal Statutory Auditors
Vote FOR the appointment or (re)election of statutory auditors, unless:
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There are serious concerns about the statutory reports presented or the audit procedures used;
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Questions exist concerning any of the statutory auditors being appointed; or
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The auditors have previously served the company in an executive capacity or can otherwise be considered affiliated with the company.
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Allocation of Income
Vote FOR approval of the allocation of income, unless:
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The dividend payout ratio has been consistently below 30 percent without adequate explanation; or
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The payout is excessive given the companys financial position.
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Amendments to Articles of Association
Vote amendments to the articles of association on a CASE-BY-CASE basis.
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Change in Company Fiscal Term
Vote FOR resolutions to change a companys fiscal term unless a companys motivation for the change is to postpone its AGM.
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Lower Disclosure Threshold for Stock Ownership
Vote AGAINST resolutions to lower the stock ownership disclosure threshold below 5 percent unless specific reasons exist to implement a lower threshold.
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Amend Quorum Requirements
Vote proposals to amend quorum requirements for shareholder meetings on a CASE-BY-CASE basis.
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Transact Other Business
Vote AGAINST other business when it appears as a voting item.
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2. BOARD OF DIRECTORS
Director Elections
Vote FOR management nominees in the election of directors, unless:
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Adequate disclosure has not been provided in a timely manner;
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There are clear concerns over questionable finances or restatements;
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There have been questionable transactions with conflicts of interest;
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There are any records of abuses against minority shareholder interests; or
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The board fails to meet minimum corporate governance standards.
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Vote FOR individual nominees unless there
are specific concerns about the individual, such as criminal wrongdoing or breach of fiduciary responsibilities.
Vote AGAINST individual
directors if repeated absences at board meetings have not been explained (in countries where this information is disclosed).
Vote on a
CASE-BY-CASE basis for contested elections of directors, e.g., the election of shareholder nominees or the dismissal of incumbent directors, determining which directors are best suited to add value for shareholders.
Vote FOR employee and/or labor representatives if they sit on either the audit or compensation committee
and
are required by law to be on those
committees. Vote AGAINST employee and/or labor representatives if they sit on either the audit or compensation committee, if they are not required to be on those committees.
Under extraordinary circumstances, vote AGAINST or WITHHOLD from directors individually, on a committee, or the entire board, due to:
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Material failures of governance, stewardship, risk oversight, or fiduciary responsibilities at the company; or
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Failure to replace management as appropriate; or
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Egregious actions related to the director(s) service on other boards that raise substantial doubt about his or her ability to effectively oversee
management and serve the best interests of shareholders at any company.
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In Europe, ISS looks at different factors to
determine a recommendation regarding director elections. The following factors are taken into account:
Director Terms
For Belgium, Denmark, Finland, France, Italy, Netherlands, Norway, Sweden, and Switzerland
, vote AGAINST the election or (re)election of any director when the term is not disclosed or when it
exceeds four years and adequate explanation for noncompliance has not been provided.
For Spain, g
enerally vote AGAINST the
(re)election of any director (except for the CEO) who will serve for a term exceeding four years. However, in determining vote recommendations on the (re)election of directors, the following additional factors will be taken into account on a
CASE-BY-CASE basis:
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Composition of the board and its committees (e.g., independence as defined by ISS criteria);
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Board functioning (attendance, evaluation);
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Company disclosure on internal rules and/or a resignation schedule to organize staggered (re)elections of the board members in order to avoid too many
reappointments coming up for simultaneous review; and
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The companys overall governance practices.
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Vote AGAINST article amendment proposals seeking extensions of director terms. In cases where a companys articles provide for a shorter limit, and where such a company wishes to extend a director
term from three to four years, for example, vote AGAINST based on the general principle that director accountability is maximized by elections with a short period of renewal.
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ISS 2012 European Proxy Voting Summary Guidelines
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B-143
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Bundling of Proposals
For France, Germany and Spain
, vote AGAINST the election or reelection of any directors if the company proposes a single slate of directors.
Board Independence
For the markets of Austria, Belgium, Germany, France, Spain, Switzerland, and the Netherlands,
vote AGAINST the election or reelection of any non-independent directors (excluding the CEO) if the
proposed board is not at least 50-percent independent (as defined by ISS director categorization guidelines). If a nominee cannot be categorized, ISS will assume that person is non-independent and include that nominee in the calculation. The
policy will apply to widely held companies* in these seven markets.
For the markets of Denmark, Norway, Finland, Sweden, Luxembourg
,
ISS will apply the same policy to recommend AGAINST non-independent directors if there is not a majority independent board, but only for those companies that are part of a local blue chip market index and/or MSCI-EAFE index.
In Ireland,
vote AGAINST non-independent directors if there is not a majority independent board, but only for those companies that are
constituents of ISE 20.
Companies that are not part of the ISE 20
will be required to have at least two independent NEDs on the board, as required by the Combined Code of Corporate Governance, as applied in Ireland. In instances where this is
not the case, ISS will consider voting against the non-independent members of the board.
For widely held companies* in Austria and Germany
that
must by law include labor representatives, ISS will require that one-third of the total board be independent. For Swedish, Norwegian, and Danish local blue chip and/or MSCI EAFE companies, this policy will apply to shareholder-elected board
members. In addition, ISS will require that one-third of the total board (shareholder-elected members and labor representatives) be independent non-executive directors.
In Portugal, companies that belong to the PSI-20 and/or MSCI EAFE index
will be required to have at least a 25 percent independent board, as recommended by the Code of Corporate Governance issued
by the Portuguese Securities Exchange. Vote AGAINST the entire slate of candidates (bundled elections) or vote AGAINST the election of any non-independent directors (unbundled elections) if board independence level does not meet the recommended
25-percent threshold.
In Italy, companies that are part of a local blue chip market index and/or MSCI-EAFE index with a controlling
shareholder
will be required to have at least one-third of independent members (33 percent), and for all other companies, at least half of the board should be independent (50 percent).
Carve-outs:
For all markets, if a company is family-controlled or has a majority shareholder, ISS will apply an independence rule that is proportionate to the economic interest of the controlling
family or majority shareholder. NOTE: controlled company is defined based on economic interest and not voting power.
For widely
held European companies* not covered by this policy, language will be included in ISS analyses indicating the preference for at least a 50 percent independent board.
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ISS 2012 European Proxy Voting Summary Guidelines
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B-144
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Disclosure of Nominee Names
Vote AGAINST the (re)election of any directors when the names of the nominees are not available at the time the ISS analysis is being written. This policy will be applied to all companies in these
markets, for bundled as well as unbundled items.
Combined Chairman/CEO
Vote AGAINST (re)election of a combined chair/CEO at widely held European companies*.
However, when the company provides assurance that the chair/CEO would only serve in the combined role on an interim basis (no more than two years), with the intent of separating the roles within a given
time frame, considerations should be given to these exceptional circumstances. In this respect, the vote recommendation would be made on a CASE-BY-CASE basis. In order for ISS to consider a favorable vote recommendation for a combined chair/CEO to
serve on an interim basis, the company would need to provide adequate control mechanisms on the board (such as a lead independent director, a high overall level of board independence, and a high level of independence on the boards key
committees).
This policy will be applied to all widely held European companies* that propose the (re)election of a combined chair/CEO to the
board, including cases where the chair/CEO is included in an election by slate.
Election of Former CEO as
Chairman of the Board
ISS will generally recommend a vote against the election or reelection of a former CEO as chairman to the
supervisory board or board of directors at widely held companies* in Germany, the U.K. and the Netherlands. In markets such as Germany, where the general meeting only elects the nominees and, subsequently, the new boards chairman, ISS will
generally recommend a vote against the election or reelection of a former CEO, unless the company has publicly confirmed prior to the general meeting that he will not proceed to become chairman of the board. Considerations should be given to any of
the following exceptional circumstances on a CASE-BY-CASE basis if:
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There are compelling reasons that justify the election or reelection of a former CEO as chairman; or
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The former CEO is proposed to become the boards chairman only on an interim or temporary basis; or
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The former CEO is proposed to be elected as the boards chairman for the first time after a reasonable cooling-off period.
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The board chairman will not receive a level of compensation comparable to the companys executives nor assume executive functions in markets where
this is applicable.
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Overboarded Directors
In markets where local law or best practice governance codes address overboarding, disclosure is sufficient (such as detailed director biographies which
include information on the directors role on the board and other external appointments both in the local market and abroad), and markets permit individual election of directors, vote against a candidate when he/she holds an excessive number of
board appointments referenced by the more stringent of the provisions prescribed in local law or best practice governance codes. An adverse vote recommendation will not be applied to a director within a company where he/she serves as CEO or chair;
instead, any adverse vote recommendations will be applied to his/her additional seats on other company boards.
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ISS 2012 European Proxy Voting Summary Guidelines
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B-145
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For markets that adopt this overboarding
principle but their governance codes do not go as far as prescribing a desired maximum number of boards or their local governance codes provide for less stringent requirements, as a general rule ISS expects directors not to hold more than a total of
five board appointments.
Appreciating that time commitment varies between the roles of an executive director, a chairman, and a non-executive
director, unless local corporate governance codes provide specific weightings, the following rule will apply:
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Executive directors are expected not to hold other executive or chairmanship positions. They may, however, hold up to two other non-executive
directorships.
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Chairmen are expected not to hold other executive positions or more than one other chairmanship position. They may, however, hold up to three other
non-executive directorships.
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NEDs who do not hold executive or chairmanship positions may hold up to four other non-executive directorships.
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ISS will take into account board positions held in global publicly listed companies.
For directors standing for (re)election at French companies, take into account board appointments as censors in French publicly listed companies.
Voto di Lista (Italy)
In Italy, for MSCI EAFE
companies, the election of directors takes place through the voto di lista mechanism (similar to slate elections). Unfortunately, the various lists are rarely released more than 10 days in advance of the meeting. Before the lists of director
nominees are disclosed, ISS will recommend a vote AGAINST the director elections at such companies. Once the various lists of nominees are disclosed, ISS will issue an alert to its clients and, if appropriate, change its vote recommendation to
support one particular slate.
One Board Seat per Director
In cases where a director holds more than one board seat and corresponding votes, manifested as one seat as a physical person plus an additional seat(s)
as a representative of a legal entity, vote AGAINST the (re)election of such legal entities and vote on the physical person.
However, an
exception is made if the representative of the legal entity holds the position of CEO. In such circumstances, vote on the legal entity and AGAINST the (re)election of the physical person.
Composition of Committees
Vote AGAINST the
(re)election of executive members of the audit or remuneration committees. ISS may vote AGAINST if the disclosure is too poor to determine whether an executive serves or will serve on a committee. If a company does not have an audit or a
remuneration committee, ISS may consider that the entire board fulfills the role of a committee. In such case, ISS may vote AGAINST the executives, including the CEO, up for election to the board.
Carve-out: Italy, Greece, Cyprus, and Portugal are excluded from applying this policy.
Vote AGAINST the (re)election of non-independent members of the audit committee and/or the remuneration committee if their (re)election would lead to a non-independent majority on the respective
committee.
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ISS 2012 European Proxy Voting Summary Guidelines
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B-146
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Carve-out: Germany, France,
Luxembourg, Italy, Greece, Cyprus, Portugal, Spain, Sweden, Norway, Finland, Denmark, and Austria are exempt from applying this policy.
These policies apply only to companies for which ISS includes overall board independence as a factor in its analysis of board elections.
Markets where local corporate governance codes prescribe specific composition requirements are assessed in accordance with compliance with their local
codes. More stringent requirements are applied to those markets whose local corporate governance codes prescribe more robust composition requirements.
Composition of the Nominating Committee (Sweden/Norway/Finland)
Vote FOR proposals in Sweden, Norway, and Finland to elect or appoint a nominating committee consisting mainly of non-board members.
Vote FOR shareholder proposals calling for disclosure of the names of the proposed candidates at the meeting, as well as the inclusion of a representative of minority shareholders in the committee.
The above policy notwithstanding, vote AGAINST proposals in Sweden to elect or appoint such a committee if the company is on the MSCI-EAFE or
local main index and the following conditions are met:
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A member of the executive management would be a member of the committee;
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More than one board member who is dependent on a major shareholder would be on the committee; or
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3.
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The chair of the board would also be the chair of the committee.
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In cases where the principles for the establishment of the nominating committee, rather than the election of the committee itself, are being voted on, vote AGAINST the adoption of the principles if any of
the above conditions are met for the current committee, and there is no publicly available information indicating that this would no longer be the case for the new nominating committee.
Election of Censors (France)
For widely held
companies*, generally vote AGAINST proposals seeking shareholder approval to elect a censor, to amend bylaws to authorize the appointment of censors, or to extend the maximum number of censors to the board.
However, vote on a CASE-BY-CASE basis when the company provides assurance that the censor would serve on a short-term basis (maximum one year) with the
intent to retain the nominee before his/her election as director. In this case, consideration shall also be given to the nominees situation (notably overboarding or other factors of concern).
In consideration of the principle that censors should be appointed on a short-term basis, vote AGAINST any proposal to renew the term of a censor or to
extend the statutory term of censors.
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ISS 2012 European Proxy Voting Summary Guidelines
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B-147
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*ISS will define a widely
held company using the following factors:
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1.
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Number of clients holding the security; and
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Membership in a major index.
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ISS Classification of DirectorsEuropean Policy 2011
Executive Director
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Employee or executive of the company;
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Any director who is classified as a non-executive, but receives salary, fees, bonus, and/or other benefits that are in line with the highest-paid
executives of the company.
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Non-Independent Non-Executive Director (NED)
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Any director who is attested by the board to be a non-independent NED;
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Any director specifically designated as a representative of a significant shareholder of the company;
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Any director who is also an employee or executive of a significant shareholder of the company;
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Any director who is nominated by a dissenting significant shareholder, unless there is a clear lack of material[5] connection with the dissident,
either currently or historically;
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Beneficial owner (direct or indirect) of at least 10 percent of the companys stock, either in economic terms or in voting rights (this may be
aggregated if voting power is distributed among more than one member of a defined group, e.g., family members who beneficially own less than 10 percent individually, but collectively own more than 10 percent), unless market best practice dictates a
lower ownership and/or disclosure threshold (and in other special market-specific circumstances);
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Government representative;
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Currently provides (or a relative[1] provides) professional services[2] to the company, to an affiliate of the company, or to an individual officer of
the company or of one of its affiliates in excess of $10,000 per year;
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Represents customer, supplier, creditor, banker, or other entity with which company maintains transactional/commercial relationship (unless company
discloses information to apply a materiality test[3]);
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Any director who has conflicting or cross-directorships with executive directors or the chairman of the company;
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Relative[1] of a current employee of the company or its affiliates;
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Relative[1] of a former executive of the company or its affiliates;
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A new appointee elected other than by a formal process through the general meeting (such as a contractual appointment by a substantial shareholder);
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Founder/co-founder/member of founding family but not currently an employee;
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Former executive (five-year cooling off period);
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ISS 2012 European Proxy Voting Summary Guidelines
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B-148
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Excessive years of service from date of first appointment, as determined by the EC Recommendation 2005/162/EC, local corporate governance codes, or
local best practice, is generally a determining factor in evaluating director independence.[4]
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Any additional relationship or principle considered to compromise independence under local corporate governance best practice guidance.
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Independent NED
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No material[5] connection, either directly or indirectly, to the company (other than a board seat) or the dissenting significant shareholder.
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Employee Representative
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Represents employees or employee shareholders of the company (classified as employee representative but considered a non-independent NED).
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Footnotes:
[1] Relative follows the definition of immediate family members which covers spouses, parents, children, stepparents,
step-children, siblings, in-laws, and any person (other than a tenant or employee) sharing the household of any director, nominee for director, executive officer, or significant shareholder of the company.
[2] Professional services can be characterized as advisory in nature and generally include the following: investment banking/financial advisory services;
commercial banking (beyond deposit services); investment services; insurance services; accounting/audit services; consulting services; marketing services; and legal services. The case of participation in a banking syndicate by a non-lead bank should
be considered a transaction (and hence subject to the associated materiality test) rather than a professional relationship.
[3] A business
relationship may be material if the transaction value (of all outstanding transactions) entered into between the company and the company or organization with which the director is associated is equivalent to either 1 percent of the companys
turnover or 1 percent of the turnover of the company or organization with which the director is associated. OR, A business relationship may be material if the transaction value (of all outstanding financing operations) entered into between the
company and the company or organization with which the director is associated is more than 10 percent of the companys shareholder equity or the transaction value, (of all outstanding financing operations), compared to the companys total
assets, is more than 5 percent.
[4] For example, the EC recommendation 2005/162/ECs definition of independence provides that in order
to remain independent, a non-executive director shall have served on the [supervisory] board for no more than 12 years. For countries governed by ISS European policy, ISS will follow the EC recommendation and apply stricter tenure limits where
recommended by local corporate governance codes or established by local best practice.
[5] For purposes of ISS director independence
classification, material will be defined as a standard of relationship financial, personal or otherwise that a reasonable person might conclude could potentially influence ones objectivity in the boardroom in a manner that would
have a meaningful impact on an individuals ability to satisfy requisite fiduciary standards on behalf of shareholders.
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ISS 2012 European Proxy Voting Summary Guidelines
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B-149
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Contested
Director Elections
For contested elections of directors, e.g. the election of shareholder nominees or the dismissal of incumbent
directors, ISS will make its recommendation on a case-by-case basis, determining which directors are best suited to add value for shareholders.
The analysis will generally be based on, but not limited to, the following major decision factors:
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Company performance relative to its peers;
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Strategy of the incumbents versus the dissidents;
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Independence of directors/nominees;
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Experience and skills of board candidates;
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Governance profile of the company;
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Evidence of management entrenchment;
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Responsiveness to shareholders;
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Whether a takeover offer has been rebuffed;
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Whether minority or majority representation is being sought.
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When analyzing a contested election of directors, ISS will generally focus on two central questions: (1) Have the dissidents proved that board change is warranted? And (2) if so, are the
dissident board nominees likely to effect positive change (i.e., maximize long-term shareholder value).
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Discharge of Directors
Generally vote FOR the discharge of directors, including members of the management board and/or supervisory board,
unless
there is reliable
information about significant and compelling controversies that the board is not fulfilling its fiduciary duties warranted by:
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A lack of oversight or actions by board members which invoke shareholder distrust related to malfeasance or poor supervision, such as operating in
private or company interest rather than in shareholder interest; or
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Any legal issues (e.g. civil/criminal) aiming to hold the board responsible for breach of trust in the past or related to currently alleged actions yet
to be confirmed (and not only the fiscal year in question), such as price fixing, insider trading, bribery, fraud, and other illegal actions; or
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Other egregious governance issues where shareholders will bring legal action against the company or its directors.
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For markets which do not routinely request discharge resolutions (e.g. common law countries or markets where discharge is not mandatory), analysts may
voice concern in other appropriate agenda items, such as approval of the annual accounts or other relevant resolutions, to enable shareholders to express discontent with the board.
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ISS 2012 European Proxy Voting Summary Guidelines
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B-150
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Director,
Officer, and Auditor Indemnification and Liability Provisions
Vote proposals seeking indemnification and liability protection for
directors and officers on a CASE-BY-CASE basis.
Vote AGAINST proposals to indemnify external auditors.
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Board Structure
Vote FOR proposals to fix board size.
Vote AGAINST the introduction of classified boards and
mandatory retirement ages for directors.
Vote AGAINST proposals to alter board structure or size in the context of a fight for control of the
company or the board.
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3. CAPITAL STRUCTURE
Share Issuance Requests
General Issuances
Vote FOR issuance requests with preemptive rights to a maximum of 100 percent over currently issued capital (33 percent for the U.K., 50 percent for France).
Vote FOR issuance requests without preemptive rights to a maximum of 20 percent of currently issued capital (5 percent for the U.K.).
For France
, vote FOR general issuance requests with preemptive rights, or without preemptive rights but with a binding priority right,
for a maximum of 50 percent over currently issued capital.
ISS may recommend a vote for issuance requests only if the share issuance
authorities periods are clearly disclosed (or implied by the application of a legal maximum duration) and in line with market-specific practices and/or recommended guidelines (e.g. issuance periods limited to 18 months for the U.K and
Netherlands).
Specific Issuances
Vote on a CASE-BY-CASE basis on all requests, with or without preemptive rights.
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Reduction of Capital
Vote FOR proposals to reduce capital for routine accounting purposes unless the terms are unfavorable to shareholders.
Vote proposals to reduce capital in connection with corporate restructuring on a CASE-BY-CASE basis.
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ISS 2012 European Proxy Voting Summary Guidelines
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B-151
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Capital
Structures
Vote FOR resolutions that seek to maintain or convert to a one-share, one-vote capital structure.
Vote AGAINST requests for the creation or continuation of dual-class capital structures or the creation of new or additional super voting shares.
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Preferred Stock
Vote FOR the creation of a new class of preferred stock or for issuances of preferred stock up to 50 percent of issued capital unless the terms of the preferred stock would adversely affect the rights of
existing shareholders.
Vote FOR the creation/issuance of convertible preferred stock as long as the maximum number of common shares that
could be issued upon conversion meets ISS guidelines on equity issuance requests.
Vote AGAINST the creation of a new class of preference
shares that would carry superior voting rights to the common shares.
Vote AGAINST the creation of blank check preferred stock unless the
board clearly states that the authorization will not be used to thwart a takeover bid.
Vote proposals to increase blank check preferred
authorizations on a CASE-BY-CASE basis.
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Debt Issuance Requests
Vote non-convertible debt issuance requests on a CASE-BY-CASE basis, with or without preemptive rights.
Vote FOR the creation/issuance of convertible debt instruments as long as the maximum number of common shares that could be issued upon conversion meets ISS guidelines on equity issuance requests.
Vote FOR proposals to restructure existing debt arrangements unless the terms of the restructuring would adversely affect the rights of
shareholders.
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Pledging of Assets for Debt
Vote proposals to approve the pledging of assets for debt on a CASE-BY-CASE basis.
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Increase in Borrowing Powers
Vote proposals to approve increases in a companys borrowing powers on a CASE-BY-CASE basis.
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ISS 2012 European Proxy Voting Summary Guidelines
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B-152
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Share
Repurchase Plans
Generally vote FOR market repurchase authorities (share repurchase programs) if the terms comply with the following
criteria:
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A repurchase limit of up to 10 percent of outstanding issued share capital (15 percent in U.K/Ireland);
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A holding limit of up to 10 percent of a companys issued share capital in treasury (on the shelf); and
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A duration of no more than five years, or such lower threshold as may be set by applicable law, regulation or code of governance best practice.
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Authorities to repurchase shares in excess of the 10 percent repurchase limit will be assessed on a case-by-case basis. ISS
may support such share repurchase authorities under special circumstances, which are required to be publicly disclosed by the company, provided that, on balance, the proposal is in shareholders interests. In such cases, the authority must
comply with the following criteria:
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A holding limit of up to 10 percent of a companys issued share capital in treasury (on the shelf); and
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A duration of no more than 18 months.
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In markets where it is normal practice not to provide a repurchase limit, ISS will evaluate the proposal based on the companys historical practice. However, ISS expects companies to disclose such
limits and, in the future, may recommend a vote against companies that fail to do so. In such cases, the authority must comply with the following criteria:
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A holding limit of up to 10 percent of a companys issued share capital in treasury (on the shelf); and
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A duration of no more than 18 months.
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In addition, ISS will recommend AGAINST any proposal where:
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The repurchase can be used for takeover defenses;
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There is clear evidence of abuse;
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There is no safeguard against selective buybacks; and/or
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Pricing provisions and safeguards are deemed to be unreasonable in light of market practice.
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For Italy and Germany, vote FOR share-repurchase plans and share reissuance plans that would use call and put options if the following criteria are met:
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The duration of the authorization is limited in time to no more than 18 months;
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The total number of shares covered by the authorization is disclosed;
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The number of shares that would be purchased with call options and/or sold with put options is limited to a maximum of 5 percent of currently
outstanding capital (or half of the total amounts allowed by law in Italy and Germany);
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A financial institution, with experience conducting sophisticated transactions, is indicated as the party responsible for the trading; and
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The company has a clean track record regarding repurchases.
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ISS 2012 European Proxy Voting Summary Guidelines
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B-153
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Reissuance of Repurchased Shares
Vote FOR requests to reissue any repurchased shares unless there is clear evidence of abuse of this authority in the past.
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Capitalization of Reserves for Bonus Issues/Increase in Par Value
Vote FOR requests to capitalize reserves for bonus issues of shares or to increase par value.
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4. COMPENSATION
Compensation Guidelines
Preamble
The assessment of compensation follows the ISS Global Principles on Executive and Director Compensation which are detailed below. These principles take into account global corporate governance best
practice.
The ISS Global Principles on Compensation underlie market-specific policies in all markets:
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1.
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Provide shareholders with clear, comprehensive compensation disclosures;
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Maintain appropriate pay-for-performance alignment with emphasis on long-term shareholder value;
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3.
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Avoid arrangements that risk pay for failure;
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Maintain an independent and effective compensation committee;
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Avoid inappropriate pay to non-executive directors.
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In line with European Commission Recommendation 2004/913/EC, ISS believes that seeking annual shareholder approval for a companys compensation policy is a positive corporate governance provision.
In applying the Five Global Principles, ISS has formulated European Compensation Guidelines which take into account local codes of
governance, market best practice, and the Recommendations published by the European Commission. ISS analyzes compensation-related proposals based on the role of the beneficiaries and has therefore divided its executive and director compensation
policy into two domains:
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I.
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Executive compensation-related proposals; and
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II.
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Non-executive director compensation-related proposals
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Executive Compensation-Related Proposals
ISS will
evaluate management proposals seeking ratification of a companys executive compensation-related items on a CASE-BY-CASE basis, and will generally recommend a vote AGAINST a companys compensation-related proposal if such proposal fails to
comply with one or a combination of several of the global principles and their corresponding rules:
|
1.
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Provide shareholders with clear and comprehensive compensation disclosures:
|
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1.1
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Information on compensation-related proposals shall be made available to shareholders in a timely manner;
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ISS 2012 European Proxy Voting Summary Guidelines
|
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B-154
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1.2
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The level of disclosure of the proposed compensation policy shall be sufficient for shareholders to make an informed decision and shall be in line with what local
market best practice standards dictate;
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1.3
|
Companies shall adequately disclose all elements of the compensation, including:
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1.3.1
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Any short- or long-term compensation component must include a maximum award limit.
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1.3.2
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Long-term incentive plans must provide sufficient disclosure of (i) the exercise price/strike price (options); (ii) discount on grant; (iii) grant
date/period; (iv) exercise/vesting period; and, if applicable, (v) performance criteria.
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1.3.3
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Discretionary payments, if applicable.
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2.
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Maintain appropriate pay-for-performance alignment with emphasis on long-term shareholder value:
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2.1
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The structure of the companys short-term incentive plan shall be appropriate.
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2.1.1
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The compensation policy must notably avoid guaranteed or discretionary compensation.
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2.2
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The structure of the companys long-term incentives shall be appropriate, including, but not limited to, dilution, vesting period, and, if applicable, performance
conditions.
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2.2.1
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Equity-based plans or awards that are linked to long-term company performance will be evaluated using ISS general policy for equity-based plans; and
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2.2.2
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For awards granted to executives, ISS will generally require a clear link between shareholder value and awards, and stringent performance-based elements.
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2.3
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The balance between short- and long-term variable compensation shall be appropriate
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2.3.1
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The companys executive compensation policy must notably avoid disproportionate focus on short-term variable element(s)
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3.
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Avoid arrangements that risk pay for failure:
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3.1
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Severance pay agreements must not be in excess of (i) 24 months pay or of (ii) any more restrictive provision pursuant to local legal requirements
and/or market best practices.
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3.2
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Arrangements with a company executive regarding pensions and post-mandate exercise of equity-based awards must not result in an adverse impact on shareholders
interests or be misaligned with good market practices.
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3.3
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The board shall demonstrate good stewardship of investors interests regarding executive compensation practices.
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3.3.1
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There shall be a clear link between the companys performance and variable awards.
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3.3.2
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There shall not be significant discrepancies between the companys performance and real executive payouts.
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4.
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Maintain an independent and effective compensation committee:
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4.1
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No executives may serve on the compensation committee.
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4.2
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In certain markets the compensation committee shall be composed of a majority of independent members, as per ISS policies on director election and board or committee
composition.
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In addition to the above, ISS will
generally recommend a vote AGAINST a compensation-related proposal if such proposal is in breach of any other supplemental market-specific ISS voting policies.
Non-Executive Director Compensation
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5.
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Avoid inappropriate pay to non-executive directors:
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ISS will generally recommend a vote FOR proposals to award cash fees to non-executive directors, and will otherwise:
Recommend a vote AGAINST where:
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Documents (including general meeting documents, annual report) provided prior to the general meeting do not mention fees paid to non-executive
directors.
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Proposed amounts are excessive relative to other companies in the country or industry.
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The company intends to increase the fees excessively in comparison with market/sector practices, without stating compelling reasons that justify the
increase.
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Proposals provide for the granting of stock options, or similarly structured equity-based compensation, to non-executive directors.
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Proposals introduce retirement benefits for non-executive directors.
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And recommend a vote on a CASE-BY-CASE basis where:
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Proposals include both cash and share-based components to non-executive directors.
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Proposals bundle compensation for both non-executive and executive directors into a single resolution.
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Equity-Based Compensation Guidelines
ISS will generally recommend a vote FOR equity based compensation proposals for employees if the plan(s) are in line with long-term shareholder interests and align the award with shareholder value. This
assessment includes, but is not limited to, the following factors:
The volume of awards transferred to participants must not be excessive:
the potential volume of fully diluted issued share capital from equity-based compensation plans must not exceed the following ISS guidelines:
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The shares reserved for all share plans may not exceed 5 percent of a companys issued share capital, except in the case of high-growth companies
or particularly well-designed plans, in which case we allow dilution of between 5 and 10 percent: in this case, we will need to have performance conditions attached to the plans which should be acceptable under ISS criteria (challenging criteria)*;
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The plan(s) must be sufficiently long-term in nature/structure: the minimum vesting period must be no less than three years
from date of grant;
The awards must be granted at market price. Discounts, if any, must be mitigated by performance criteria or other
features that justify such discount.
If applicable, performance standards must be fully disclosed, quantified, and long-term, with relative
performance measures preferred.
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* Market-specific provisions for France:
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The potential volume from equity-based compensation plans must not exceed 10 percent of fully diluted issued share capital.
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In addition, for companies that refer to the AFEP-MEDEF Code, all awards (including stock options and warrants) to executives shall be conditional upon
challenging performance criteria or premium pricing. For companies referring to the Middlenext Code (or not referring to any code) at least part of the awards to executives shall be conditional upon performance criteria or premium pricing. In both
cases, free shares shall remain subject to performance criteria for all beneficiaries.
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Finally, for large- and mid-cap companies, the companys average three-year unadjusted burn rate (or, if lower, on the maximum volume per year
implied by the proposal made at the general meeting) must not exceed the mean plus one standard deviation of its sector but no more than one percentage point from the prior year sector cap.
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French Burn Rate Table for 2012
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GICS
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SECTOR
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Mean
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|
|
Standard Deviation
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|
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2012 Burn Rate Cap
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1010
|
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ENERGY
|
|
|
0.95
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%
|
|
|
0.73
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%
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|
|
1.69
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%
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1510
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MATERIALS
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|
|
0.40
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%
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|
|
0.36
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%
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|
|
0.76
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%
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2010-2030
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INDUSTRIALS
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|
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0.66
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%
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|
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0.58
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%
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|
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1.24
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%
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2510-2550
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CONSUMER DISCRETIONARY
|
|
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0.64
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%
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|
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0.44
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%
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|
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1.09
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%
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3010-3030
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CONSUMER STAPLES
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|
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0.44
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%
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|
|
0.22
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%
|
|
|
0.66
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%
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3510-3520
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HEALTHCARE
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|
|
0.60
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%
|
|
|
0.65
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%
|
|
|
1.25
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%
|
4010-4040
|
|
FINANCIALS
|
|
|
0.40
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%
|
|
|
0.46
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%
|
|
|
0.86
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%
|
4510-5010
|
|
TECHNOLOGY & TELECOM
|
|
|
1.44
|
%
|
|
|
1.04
|
%
|
|
|
2.48
|
%
|
5510
|
|
UTILITIES
|
|
|
0.44
|
%
|
|
|
0.45
|
%
|
|
|
0.89
|
%
|
u
u
u
u
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Compensation-Related Voting Sanctions
Should a company be deemed to have egregious remuneration practices (as a result of one or a combination of several factors highlighted above) and has not followed market practice by submitting a
resolution on executive compensation, vote AGAINST other appropriate resolutions as a mark of discontent against such practices.
An adverse vote recommendation could be applied to any of the following on a case-by case basis:
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1.
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The (re)election of members of the remuneration committee;
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|
2.
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The discharge of directors; or
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|
3.
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The annual report and accounts.
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Failure to
propose a resolution on executive compensation to shareholders in a market where this is routine practice may, by itself, lead to one of the above adverse vote recommendations regardless of the companies remuneration practices.
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5. OTHER
ITEMS
Reorganizations/Restructurings
Vote reorganizations and restructurings on a CASE-BY-CASE basis.
u
u
u
u
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Mergers and Acquisitions
Vote CASE-BY-CASE on mergers and acquisitions taking into account the following:
For every
M&A analysis, ISS reviews publicly available information as of the date of the report and evaluates the merits and drawbacks of the proposed transaction, balancing various and sometimes countervailing factors including:
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ValuationIs the value to be received by the target shareholders (or paid by the acquirer) reasonable? While the fairness opinion may provide an
initial starting point for assessing valuation reasonableness, ISS places emphasis on the offer premium, market reaction, and strategic rationale.
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Market reactionHow has the market responded to the proposed deal? A negative market reaction will cause ISS to scrutinize a deal more closely.
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Strategic rationaleDoes the deal make sense strategically? From where is the value derived? Cost and revenue synergies should not be overly
aggressive or optimistic, but reasonably achievable. Management should also have a favorable track record of successful integration of historical acquisitions.
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Conflicts of interestAre insiders benefiting from the transaction disproportionately and inappropriately as compared to non-insider shareholders?
ISS will consider whether any special interests may have influenced these directors and officers to support or recommend the merger.
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GovernanceWill the combined company have a better or worse governance profile than the current governance profiles of the respective parties to
the transaction? If the governance profile is to change for the worse, the burden is on the company to prove that other issues (such as valuation) outweigh any deterioration in governance.
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Vote AGAINST if the companies do not provide sufficient information upon request to make an informed voting decision.
u
u
u
u
u
Mandatory Takeover Bid Waivers
Vote proposals to waive mandatory takeover bid requirements on a CASE-BY-CASE basis.
u
u
u
u
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Reincorporation Proposals
Vote reincorporation proposals on a CASE-BY-CASE basis.
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Expansion
of Business Activities
Vote FOR resolutions to expand business activities unless the new business takes the company into risky areas.
u
u
u
u
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Related-Party Transactions
In evaluating resolutions that seek shareholder approval on related-party transactions (RPTs), vote on a case-by-case basis, considering factors including, but not limited to, the following:
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The parties on either side of the transaction;
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The nature of the asset to be transferred/service to be provided;
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The pricing of the transaction (and any associated professional valuation);
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The views of independent directors (where provided);
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The views of an independent financial adviser (where appointed);
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Whether any entities party to the transaction (including advisers) is conflicted; and
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The stated rationale for the transaction, including discussions of timing.
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If there is a transaction that ISS deemed problematic and that was not put to a shareholder vote, ISS may recommend against the election of the director involved in the related-party transaction or the
full board.
u
u
u
u
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Antitakeover Mechanisms
Generally vote AGAINST all antitakeover proposals, unless they are structured in such a way that they give shareholders the ultimate decision on any proposal or offer.
u
u
u
u
u
Shareholder Proposals
Vote all shareholder proposals on a CASE-BY-CASE basis.
Vote FOR proposals that would improve
the companys corporate governance or business profile at a reasonable cost.
Vote AGAINST proposals that limit the companys
business activities or capabilities or result in significant costs being incurred with little or no benefit.
u
u
u
u
u
Authority to Reduce Minimum Notice Period for Calling a Meeting
A recommendation to approve the enabling authority proposal would be on the basis that ISS would generally expect companies to call EGMs/GMs
using a notice period of less than 21 days only in limited circumstances where a shorter notice period will be to the advantage of shareholders as a whole, for example, to keep a period
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B-159
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of uncertainty about the future of the company to a minimum. This is particularly true of capital raising proposals or other price sensitive transactions. By definition, AGMs, being regular
meetings of the company, should not merit a notice period of less than 21 days.
In a market where local legislation permits an EGM/GM to be
called at no less than 14-days notice, ISS will generally recommend in favor of a resolution to approve the enabling authority if the company discloses that the shorter notice period of between 20 and 14 days would not be used as a matter of
routine for such meetings, but only when the flexibility is merited by the business of the meeting. Where the proposal(s) at a given EGM/GM is (are) not time-sensitive, such as the approval of incentive plans, ISS would not expect a company to
invoke the shorter notice notwithstanding any prior approval of the enabling authority proposal by shareholders.
In evaluating an enabling
authority proposal, ISS would first require that the company make a clear disclosure of its compliance with any hurdle conditions for the authority imposed by applicable law, such as the provision of an electronic voting facility for shareholders.
In addition, with the exception of the first AGM at which approval of the enabling authority is sought following implementation of the European Shareholder Rights Directive, when evaluating an enabling authority proposal ISS will take into
consideration the companys use (if any) of shorter notice periods in the preceding year to ensure that such shorter notice periods were invoked solely in connection with genuinely time-sensitive matters. Where the company has not limited its
use of the shorter notice periods to such time sensitive-matters and fails to provide a clear explanation for this, ISS will consider a vote AGAINST the enabling authority for the coming year.
u
u
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DISCLOSURE/DISCLAIMER
This document and all of the information contained in it, including without limitation all text, data, graphs, and charts (collectively, the Information) is the property of Institutional
Shareholder Services Inc. (ISS), its subsidiaries, or, in some cases third party suppliers.
The Information has not been
submitted to, nor received approval from, the United States Securities and Exchange Commission or any other regulatory body. None of the Information constitutes an offer to sell (or a solicitation of an offer to buy), or a promotion or
recommendation of, any security, financial product or other investment vehicle or any trading strategy, and ISS does not endorse, approve or otherwise express any opinion regarding any issuer, securities, financial products or instruments or trading
strategies.
The user of the Information assumes the entire risk of any use it may make or permit to be made of the Information.
ISS MAKES NO EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS WITH RESPECT TO THE INFORMATION AND EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING,
WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS, NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION.
Without limiting any of the foregoing and to the maximum extent permitted by law, in no event shall ISS have any liability regarding any of the
Information for any direct, indirect, special, punitive, consequential (including lost profits) or any other damages even if notified of the possibility of such damages. The foregoing shall not exclude or limit any liability that may not by
applicable law be excluded or limited.
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B-160
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2012 Hong Kong Proxy Voting Guidelines
December 19, 2011
Institutional Shareholder
Services Inc.
Copyright
©
2012 by ISS
www.issgovernance.com
B-161
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ISS
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www.issgovernance.com
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ISS 2012 Hong Kong Proxy Voting Guidelines
Effective for Meetings on or after Feb. 1, 2012
Published Dec. 19, 2011
Table of Contents
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B-162
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Board of Directors
The SEHK listing rules now require that at least three independent directors be appointed to boards of listed companies. Companies are likewise required
to form audit committees composed of three nonexecutive directors, a majority of whom must be independent. The committee must have as a member an independent director with appropriate professional qualifications or accounting or related financial
management expertise. The establishment of a remuneration committee is not required in Hong Kong, but the new listing rules state that, if such a committee exists, a majority of the committees members must be independent.
In cases when companies bundle the election of directors in one voting item and do not disclose the names of nominees, ISS opposes the election, as such
practice restricts shareholders ability to block the election of individuals unfit to hold office.
Election of Directors
Generally vote FOR director nominees to the board. Vote AGAINST any nominee who:
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|
|
Is classified by the company as independent, but fails to meet the ISS criteria for independence;
|
|
|
|
Has been a partner of the companys auditor within the last three years, and serves on the audit committee;
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Had attended less than 75 percent of board meetings over the most recent two years, without a satisfactory explanation;
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Is an executive director serving on the remuneration committee or nomination committee, and the committee is not majority independent; or
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|
|
|
Is an executive director serving on the audit committee.
|
If the board is composed of less than one-third independent directors, additional criteria apply. In such cases, vote AGAINST any nominee who:
|
|
|
Is an executive director. If more than one executive director is up for election, vote against only one generally the director with the worst
attendance record;
|
|
|
|
Serves as a representative of one substantial shareholder; and the board is less than one-third independent because of a preponderance of executive
directors and representatives of the substantial shareholder. Vote against only one representative of the substantial shareholder generally the director with the worst attendance record.
|
Vote FOR the election of a CEO or company founder who is integral to the company.
ISS will recommend voting against shareholder-nominated candidates who lack board endorsement, unless they demonstrate a clear ability to contribute positively to board deliberations.
Under extraordinary circumstances, vote AGAINST or WITHHOLD from individual directors, members of a committee, or the entire board, due to:
|
|
|
Material failures of governance, stewardship, risk oversight, or fiduciary responsibilities at the company;
|
|
|
|
Failure to replace management as appropriate; or
|
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Egregious actions related to a directors service on other boards that raise substantial doubt about his or her ability to effectively oversee
management and serve the best interests of shareholders at any company.
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Remuneration
Director Fees
ISS generally supports resolutions regarding directors fees unless they are excessive relative to fees paid by other companies of similar size.
Compensation Plans
ISS will recommend voting against an option scheme if:
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|
|
The maximum dilution level for the scheme exceeds ISS guidelines of 5 percent of issued capital for a mature company and 10 percent for a growth
company. However, ISS will support plans at mature companies with dilution levels up to 10 percent if the plan includes other positive features such as challenging performance criteria and meaningful vesting periods as these features partially
offset dilution concerns by reducing the likelihood that options will become exercisable unless there is a clear improvement in shareholder value;
and/or
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Directors eligible to receive options under the scheme are involved in the administration of the scheme.
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Audit
An
auditor who has been removed from office has the right to attend the AGM and to make statements to members at the AGM immediately following removal. Auditors can require subsidiaries of holding companies to provide detailed information regarding
their operations an important point in Hong Kong, because holding companies are becoming the favored corporate structure for Hong Kong conglomerates.
The right of auditors to attend AGMs following removal from office is an important safeguard for shareholders because it forces the company to justify its actions. Therefore, companies usually provide
reasons for changes of auditors, and opposing the reappointment of auditors would only take place in extreme circumstances.
The practice of
auditors providing non-audit services to companies is problematic. While large auditors may have effective internal barriers to ensure that there are no conflicts of interest, an auditors ability to remain objective becomes questionable when
fees paid to the auditor for non-audit services such as management consulting, general bookkeeping, and special situation audits exceed the standard annual audit fees. While some compensation for non-audit services is customary, the importance of
maintaining the independence of the auditor is paramount. If fees from non-audit services become significant without any clear safeguards against conflicts of interest, ISS recommends opposing the auditors reappointment.
With regard to the proposals to (re)appoint auditors, ISS will recommend supporting the appointment of auditors and authorizing the board to fix their
remuneration, unless:
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There are serious concerns about the accounts presented or the audit procedures used;
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The auditor is being changed without explanation;
or
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Non-audit related fees are substantial or are routinely in excess of standard annual audit fees.
|
Whilst ISS will consider the nature and scope of non-audit fees when assessing their magnitude, where non-audit fees have constituted more than 50
percent of total auditor compensation during three out of the five most recent financial years, ISS will ordinarily not recommend support for the reelection of the audit firm.
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Share Issuance Requests
General Issuance Mandate
Hong Kong companies routinely seek shareholder approval to authorize their boards to:
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Issue shares up to 20 percent of existing capital without preemptive rights (General Issuance Mandate);
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Repurchase shares of up to 10 percent of issued capital (Repurchase Mandate);
and
|
Reissue repurchased shares by extending the General Issuance Mandate to include the number of shares repurchased (Share Reissuance Mandate).
This section deals with the General Issuance Mandate, while the other two mandates are discussed below. The interrelationship between the three items is,
however, extremely important because the Share Reissuance Mandate extends the boards authority to issue shares without preemptive rights from 20 percent to 30 percent, assuming a 20 percent request has been made under the General Issuance
Mandate.
Hong Kong companies routinely ask shareholders to grant the board of directors a general mandate to issue shares without
preemptive rights, at least once every year. This mandate, pursuant to the Listing Rules, allows companies to issue shares of up to 20 percent of issued capital without preemptive rights at a discount to market prices of up to 20 percent (or more
under special circumstances). This is a routine item on AGM agendas, but companies can also seek to renew (or refresh) the share issuance amount at an EGM later in the year. The authority is limited to one year or the next general
meeting, as revoked or renewed by shareholders.
In recent years, many institutional investors have voted against all requests to issue shares
without preemptive rights in Hong Kong as this mandate is subject to abuse by companies that could issue shares at steep discounts, potentially to related parties, and renew the share issuance amount several times within a period of one year. A
small number of Hong Kong companies have, recently, made mandate requests smaller than the 20 percent maximum that the Listing Rules allow.
Taking account of the views of a wide range of institutional investors with investments in Hong Kong companies, ISS will now recommend a vote supporting
the General Issuance Mandate for companies that:
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Limit the aggregate issuance request that is, for the General Issuance Mandate and the Share Reissuance Mandate combined to 10 percent or
less of the existing issued share capital (rather than the maximum 20 percent + 10 percent that the Listing Rules permit companies to request);
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Limit the discount to 10 percent of the market price of shares (rather than the maximum 20 percent permitted by the Listing Rules);
and
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Have no history of renewing the General Issuance Mandate several times within a period of one year.
|
Share Repurchase Plans (Repurchase Mandate)
The Hong Kong Code on Share Repurchases, enacted in 1991, made stock repurchases legal under specific guidelines. Companies usually request the authority under the title General Mandate to
Repurchase Shares, and the authority lasts for one year or until the next shareholder meeting. Repurchase programs are limited to 10 percent of the companys outstanding capital on the date the authority is granted. In addition, the funds
to make the repurchases should be obtained from reserves established or authorized for this purpose. Companies are allowed to purchase ordinary shares or warrants on the open market through brokers, but purchases cannot knowingly be made from
specific individuals or shareholders. Repurchased shares must be destroyed and removed from the companys issued capital. In some cases, however, the company seeks separate authority to reissue the shares repurchased over and above the General
Issuance Mandate (see Share Reissuance Mandate, below).
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There are several other aspects of the authority designed to protect
shareholders interests. As with the General Issuance Mandate, most companies use the exact wording from the official text of an amendment when making requests for such authorizations or when amending their articles to allow use of the
authority and establishing reserves for that purpose.
Reissuance of Shares Repurchased (Share Reissuance
Mandate)
Companies may request board authorization to reissue any shares repurchased during the year under the Repurchase Mandate without
limiting the General Issuance Mandate. This is known as the Share Reissuance Mandate. This authority is limited to shares repurchased in a given year and is thus limited to the maximum 10 percent allowed under the Repurchase Mandate. It is valid for
one year. The Share Reissuance Mandate extends the boards authority to issue shares without preemptive rights from 20 percent to 30 percent, assuming a 20 percent request has been made under the General Issuance Mandate.
The Share Reissuance Mandate gives the board power to issue shares on the same terms and conditions (for example, in relation to discount to market
price) as exist under the General Issuance Mandate.
ISS will recommend a vote supporting the Share Reissuance Mandate only if:
|
|
|
The aggregate issuance request that is, for the General Issuance Mandate and the Share Reissuance Mandate combined is limited to 10
percent or less of the existing issued share capital (rather than the maximum 20 percent + 10 percent that the Listing Rules permit companies to request);
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|
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The General Issuance Mandate request limits the discount to 10 percent of the market price of shares (rather than the maximum 20 percent permitted by
the Listing Rules);
and
|
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|
The company has no history of renewing the General Issuance Mandate several times within a period of one year if it has recommended For the General
Issuance Mandate.
|
Related-Party Transactions
ISS assesses related-party transactions on a case-by-case basis, using the methodology described under Mergers and Acquisitions in this document.
Mergers & Acquisitions
Merger and acquisition activity is regulated by the Hong Kong Code on Mergers and Takeovers, which does not have the force of law but does have the support of the SFC and the SEHK. Any person acquiring
shares worth 30 percent of a companys voting rights must make a general cash offer to other shareholders. The offer should be at a price no less than the highest price paid by the person or group during the preceding six months. Any person
holding between 30 percent and 50 percent of the voting rights who acquires an additional 2 percent of the voting rights during any 12-month period must also make a general offer for the rest of the company.
Some M&A transactions require shareholder approval in Hong Kong. For example, privatization proposals, where a major shareholder wishes to buy-out
the minority shareholders in a listed company; very substantial acquisitions of assets; and very substantial disposals of assets.
ISS
evaluates merger and restructuring transactions on a case-by-case basis, giving consideration to economic, operational, and governance factors. Our analyses are based on the following principles:
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Current shareholders viewpoint:
All analyses are conducted from the point of view of enhancing long-term shareholder returns for the
companys existing shareholders. Since transactions will often involve
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more than one corporation, this may lead to contradictory recommendations. It is important for investors to evaluate our recommendations in light of their relative investment holdings. If an
investor holds many shares of company A, for whom a transaction is deemed to be favorable, and relatively few shares of company B, for whom a transaction is held to be unfavorable, it may be in the best interests of the investor to vote for the
transaction for both companies rather than follow ISSs recommendations.
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Enhancing shareholder value:
The fundamental objective of these analyses is to determine whether a transaction will enhance shareholder value.
While the post-transaction governance structure is an important factor in the decision, the paramount concern is whether the transaction makes economic sense and is expected to produce superior shareholder returns. If poor governance is being
introduced as a result of the transaction, the company must demonstrate that the economic benefits clearly outweigh any reduction in shareholder rights.
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Independent evaluation:
ISS prefers to see a fairness opinion prepared by a recognized investment banking firm. In transactions where inside
directors or management have a conflict of interest, we prefer the assurance that the transaction was reviewed by the independent directors.
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Structure of analysis
For every M&A analysis, ISS reviews
publicly available information and evaluates the merits and drawbacks of the proposed transaction, balancing various and sometimes countervailing factors including:
Is the value to be received by the target shareholders (or paid by the acquirer) reasonable? If a fairness opinion has been prepared, it
provides an initial starting point for assessing valuation reasonableness, but ISS also places emphasis on the offer premium, market reaction, and strategic rationale.
How has the market responded to the proposed deal? A negative market reaction will cause ISS to scrutinize a deal more closely.
Does the deal make sense strategically? From where is the value derived? Cost and revenue synergies should not be overly aggressive or optimistic, but reasonably achievable. Management should also have a
favorable track record of successful integration of historical acquisitions.
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Negotiations and process
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Were the terms of the transaction negotiated at arms-length? Was the process fair and equitable? A fair process helps to ensure the best price for shareholders.
Are insiders benefiting from the transaction disproportionately and inappropriately as compared to non-insider shareholders? As the result of potential conflicts, the directors and officers of the company
may be more likely to vote to approve a merger than if they did not hold these interests. ISS will consider whether these interests may have influenced these directors and officers to support or recommend the merger.
Will the combined company have a better or worse governance profile than the respective current governance profiles of the respective
parties to the transaction? If the governance profile is to change for the
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worse, the burden is on the company to prove that other issues (such as valuation) outweigh any deterioration in governance.
ISS Analytical Focus
The case-by-case basis is the
appropriate and correct approach to analyzing M&A, but the emphasis of any ISS analysis will be first and foremost on shareholder value. ISS recognizes the importance of other factors, including corporate governance, to our clients, yet cases
where corporate governance dominate an M&A vote decision will be rare.
Moreover, ISS cannot hold itself out as an industry expert. Any
ISS analysis of strategic rationale will be limited to general comments on the typical strategic rationales themselves (e.g., economies of scale, aggressive/conservative synergy assumptions, horizontal vs. vertical vs. conglomerate mergers, etc.).
In short, our vote recommendation will be based on an analysis of shareholder value, which itself can be affected by ancillary factors such
as the negotiation process. However, our research product can be distinguished from traditional brokers analysis by the inclusion of intelligent discussions, where appropriate, of such ancillary factors.
If the shareholder value is indeed fair, then all the other considerations listed above (e.g., conflicts, process, etc.) become secondary. However,
negative factors may indicate that the valuation of a proposed transaction is not in fact fair. For example, a poor process can lead to a less than ideal valuation, or excessive change-in-control payments may transfer some of the
rightful value due shareholders to conflicted insiders. In these cases, ISS will scrutinize a deals valuation more closely to determine whether it is fair to shareholders despite the applicable negative ancillary factors. A transaction can be
fair from a valuation standpoint despite being unfair in other aspects. In such cases, shareholder value is the trump card.
Asset Divestments/Purchases
Divestments
Vote recommendations on asset sales will be determined on a case-by-case basis after considering:
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Impact on the balance sheet/working capital;
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Potential elimination of diseconomies
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Anticipated financial and operating benefits;
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Anticipated use of funds;
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Value received for the asset; accountants report; fairness opinion (if any);
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How the deal was negotiated;
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Asset Purchases
As with disposals, vote recommendations on asset sales will be determined on a case-by-case basis taking into account:
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Purchase price, including earnout and contingent payments;
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independent accountants report;
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Fairness opinion (if any);
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Financial and strategic benefits;
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How the deal was negotiated;
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Other alternatives for the business;
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Noncompletion risk (companys going concern prospects, possible bankruptcy).
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Disclosure/Disclaimer
This document and all of the information contained in it, including without limitation all text, data, graphs, and charts (collectively, the Information) is the property of Institutional
Shareholder Services Inc. (ISS), its subsidiaries, or, in some cases third party suppliers.
The Information has not been
submitted to, nor received approval from, the United States Securities and Exchange Commission or any other regulatory body. None of the Information constitutes an offer to sell (or a solicitation of an offer to buy), or a promotion or
recommendation of, any security, financial product or other investment vehicle or any trading strategy, and ISS does not endorse, approve or otherwise express any opinion regarding any issuer, securities, financial products or instruments or trading
strategies.
The user of the Information assumes the entire risk of any use it may make or permit to be made of the Information.
ISS MAKES NO EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS WITH RESPECT TO THE INFORMATION AND EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING,
WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS, NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION.
Without limiting any of the foregoing and to the maximum extent permitted by law, in no event shall ISS have any liability regarding any of the
Information for any direct, indirect, special, punitive, consequential (including lost profits) or any other damages even if notified of the possibility of such damages. The foregoing shall not exclude or limit any liability that may not by
applicable law be excluded or limited.
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2012 International Proxy Voting Summary Guidelines
Dec. 19, 2011
Institutional Shareholder Services Inc.
Copyright
©
2011 by ISS
www.issgovernance.com
B-170
ISS 2012
International Proxy Voting Summary Guidelines
Effective for Meetings on or after Feb. 1, 2012
Published Dec. 19, 2011
The
following is a condensed version of the proxy voting recommendations contained in ISS International Proxy Voting Manual. Note that markets covered in this document exclude the U.S., Canada, Western European markets, Australia, New Zealand, and
China, which are presented separately. In addition, ISS has country- and market-specific policies, which are not captured below.
Table of
Contents
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INTRODUCTION
The primary purpose of a public corporation is to create sustainable value for its shareowners. To that end, ISS designs its proxy voting guidelines to
enhance shareholders long-term economic interests. ISS Benchmark proxy voting guidelines serve as a tool to assist institutional investors in meeting their fiduciary requirements with respect to voting by promoting shareholder value
creation and risk mitigation at their portfolio firms.
ISS reviews and updates its proxy voting guidelines each year, taking into account
emerging issues and trends, the evolution of market standards, regulatory changes, and feedback provided by ISS institutional clients.
ISS robust and transparent
policy formulation process
includes an exhaustive review of relevant empirical studies and other factual data, an
annual
policy survey
of institutional clients and corporate issuers, policy roundtables with a wide range of industry constituents, and an open
comment period
on draft policy changes. ISS also conducts internal research to validate
assumptions and policy positions.
The Benchmark Policy Guidelines consider market-specific recommended best practices, transparency, and
disclosure when addressing issues such as board structure, director accountability, corporate governance standards, executive compensation, shareholder rights, corporate transactions, and social/environmental issues.
ISS policy guidelines require the consideration of company-specific circumstances. When issuing a vote recommendation on a proposal, ISS considers
historical operating and investment performance, company disclosure (and proponent/dissident disclosure, if applicable), the companys governance structure and historical practices, and its industry.
In applying these policies, ISS often engages with public issuers, shareholders, activists, and other stakeholders to seek additional information and to
gain insight and context in order to provide our clients with informed vote recommendations. This engagement process enhances dialogue and promotes a higher level of understanding between investors and the companies in which they invest.
In formulating proxy voting policies, ISS assesses the potential costs and benefits of the adoption or rejection of the underlying ballot items. Where
the economic impact of a ballot item is not apparent and may involve trade-offs, the guidelines direct analysts to consider the economic consequences as well as potential risks to shareholders of approval.
This document presents ISS Benchmark International Corporate Governance Policies. The document, along with other policy documents, is available on
our Web site under the
Policy Gateway
. If you have any questions, please contact
usresearch@issgovernance.com
.
These policies
will be effective for meetings on or after Feb. 1, 2012.
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1.
OPERATIONAL ITEMS
Financial Results/Director and Auditor Reports
Vote FOR approval of financial statements and director and auditor reports, unless:
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There are concerns about the accounts presented or audit procedures used; or
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The company is not responsive to shareholder questions about specific items that should be publicly disclosed.
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Appointment of Auditors and Auditor Fees
Vote FOR the (re)election of auditors and/or proposals authorizing the board to fix auditor fees, unless:
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There are serious concerns about the procedures used by the auditor;
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There is reason to believe that the auditor has rendered an opinion, which is neither accurate nor indicative of the companys financial position;
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External auditors have previously served the company in an executive capacity or can otherwise be considered affiliated with the company;
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Name of the proposed auditors has not been published;
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The auditors are being changed without explanation; or
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Fees for non-audit services exceed standard annual audit-related fees (only applies to companies on the MSCI EAFE index and/or listed on any country
main index).
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In circumstances where fees for non-audit services include fees related to significant one-time capital
structure events (initial public offerings, bankruptcy emergencies, and spinoffs) and the company makes public disclosure of the amount and nature of those fees, which are an exception to the standard non-audit fee category, then such
fees may be excluded from the non-audit fees considered in determining the ratio of non-audit to audit fees.
For concerns related to the
audit procedures, independence of auditors, and/or name of auditors, ISS may recommend AGAINST the auditor (re)election. For concerns related to fees paid to the auditors, ISS may recommend AGAINST remuneration of auditors if this is a separate
voting item; otherwise ISS may recommend AGAINST the auditor election.
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Appointment of Internal Statutory Auditors
Vote FOR the appointment or (re)election of statutory auditors, unless:
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There are serious concerns about the statutory reports presented or the audit procedures used;
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Questions exist concerning any of the statutory auditors being appointed; or
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The auditors have previously served the company in an executive capacity or can otherwise be considered affiliated with the company.
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Allocation of Income
Vote FOR approval of the allocation of income, unless:
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The dividend payout ratio has been consistently below 30 percent without adequate explanation; or
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The payout is excessive given the companys financial position.
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Stock (Scrip) Dividend Alternative
Vote
FOR most stock (scrip) dividend proposals.
Vote AGAINST proposals that do not allow for a cash option unless management demonstrates that the
cash option is harmful to shareholder value.
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Amendments to Articles of Association
Vote amendments to the articles of association on a CASE-BY-CASE basis.
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Change in Company Fiscal Term
Vote FOR resolutions to change a companys fiscal term unless a companys motivation for the change is to postpone its AGM.
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Lower Disclosure Threshold for Stock Ownership
Vote AGAINST resolutions to lower the stock ownership disclosure threshold below 5 percent unless specific reasons exist to implement a lower threshold.
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Amend Quorum Requirements
Vote proposals to amend quorum requirements for shareholder meetings on a CASE-BY-CASE basis.
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Transact Other Business
Vote AGAINST other business when it appears as a voting item.
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2. BOARD
OF DIRECTORS
Director Elections
Vote FOR management nominees in the election of directors, unless:
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Adequate disclosure has not been provided in a timely manner;
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There are clear concerns over questionable finances or restatements;
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There have been questionable transactions with conflicts of interest;
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There are any records of abuses against minority shareholder interests; or
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The board fails to meet minimum corporate governance standards.
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Vote FOR individual nominees unless there are specific concerns about the individual, such as criminal wrongdoing or breach of fiduciary responsibilities.
Vote AGAINST individual directors if repeated absences at board meetings have not been explained (in countries where this information is disclosed).
Vote on a CASE-BY-CASE basis for contested elections of directors, e.g. the election of shareholder nominees or the dismissal of incumbent
directors, determining which directors are best suited to add value for shareholders.
Vote FOR employee and/or labor representatives if they
sit on either the audit or compensation committee
and
are required by law to be on those committees. Vote AGAINST employee and/or labor representatives if they sit on either the audit or compensation committee, if they are not required to be
on those committees.
Under extraordinary circumstances, vote AGAINST individual directors, members of a committee, or the entire board, due
to:
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Material failures of governance, stewardship, risk oversight, or fiduciary responsibilities at the company;
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Failure to replace management as appropriate; or
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Egregious actions related to a directors service on other boards that raise substantial doubt about his or her ability to effectively oversee
management and serve the best interests of shareholders at any company.
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ISS International Classification of Directors on the following page.]
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ISS
Classification of DirectorsInternational Policy 2011
Executive Director
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Employee or executive of the company;
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Any director who is classified as a non-executive, but receives salary, fees, bonus, and/or other benefits that are in line with the highest-paid
executives of the company.
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Non-Independent Non-Executive Director (NED)
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Any director who is attested by the board to be a non-independent NED;
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Any director specifically designated as a representative of a significant shareholder of the company;
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Any director who is also an employee or executive of a significant shareholder of the company;
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Any director who is nominated by a dissenting significant shareholder, unless there is a clear lack of material[5] connection with the dissident,
either currently or historically;
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Beneficial owner (direct or indirect) of at least 10 percent of the companys stock, either in economic terms or in voting rights (this may be
aggregated if voting power is distributed among more than one member of a defined group, e.g., family members who beneficially own less than 10 percent individually, but collectively own more than 10 percent), unless market best practice dictates a
lower ownership and/or disclosure threshold (and in other special market-specific circumstances);
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Government representative;
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Currently provides (or a relative[1] provides) professional services[2] to the company, to an affiliate of the company, or to an individual officer of
the company or of one of its affiliates in excess of $10,000 per year;
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Represents customer, supplier, creditor, banker, or other entity with which company maintains transactional/commercial relationship (unless company
discloses information to apply a materiality test[3]);
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Any director who has conflicting or cross-directorships with executive directors or the chairman of the company;
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Relative[1] of a current employee of the company or its affiliates;
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Relative[1] of a former executive of the company or its affiliates;
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A new appointee elected other than by a formal process through the General Meeting (such as a contractual appointment by a substantial shareholder);
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Founder/co-founder/member of founding family but not currently an employee;
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Former executive (five-year cooling off period);
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Years of service is generally not a determining factor unless it is recommended best practice in a market and/or in extreme circumstances, in which
case it may be considered.[4]
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Any additional relationship or principle considered to compromise independence under local corporate governance best practice guidance.
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Independent NED
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No material[5] connection, either directly or indirectly, to the company (other than a board seat) or the dissenting significant shareholder.
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Employee Representative
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Represents employees or employee shareholders of the company (classified as employee representative but considered a non-independent NED).
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Footnotes:
[1] Relative follows the definition of immediate family members which covers spouses, parents, children, stepparents,
step-children, siblings, in-laws, and any person (other than a tenant or employee) sharing the household of any director, nominee for director, executive officer, or significant shareholder of the company.
[2] Professional services can be characterized as advisory in nature and generally include the following: investment banking/financial advisory services;
commercial banking (beyond deposit services); investment services; insurance services; accounting/audit services; consulting services; marketing services; and legal services. The case of participation in a banking syndicate by a non-lead bank should
be considered a transaction (and hence subject to the associated materiality test) rather than a professional relationship.
[3] A business
relationship may be material if the transaction value (of all outstanding transactions) entered into between the company and the company or organization with which the director is associated is equivalent to either 1 percent of the companys
turnover or 1 percent of the turnover of the company or organization with which the director is associated. OR, A business relationship may be material if the transaction value (of all outstanding financing operations) entered into between the
company and the company or organization with which the director is associated is more than 10 percent of the companys shareholder equity or the transaction value, (of all outstanding financing operations), compared to the companys total
assets, is more than 5 percent.
[4] For example, in continental Europe, directors with a tenure exceeding 12 years will be considered
non-independent. In the United Kingdom and Ireland, directors with a tenure exceeding nine years will be considered non-independent, unless the company provides sufficient and clear justification that the director is independent despite his long
tenure.
[5] For purposes of ISS director independence classification, material will be defined as a standard of
relationship financial, personal or otherwise that a reasonable person might conclude could potentially influence ones objectivity in the boardroom in a manner that would have a meaningful impact on an individuals ability to satisfy
requisite fiduciary standards on behalf of shareholders.
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Contested Director Elections
For contested elections of directors, e.g. the election of shareholder nominees or the dismissal of incumbent directors, ISS will make its recommendation on a case-by-case basis, determining which
directors are best suited to add value for shareholders.
The analysis will generally be based on, but not limited to, the following major
decision factors:
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Company performance relative to its peers;
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Strategy of the incumbents versus the dissidents;
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Independence of directors/nominees;
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Experience and skills of board candidates;
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Governance profile of the company;
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Evidence of management entrenchment;
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Responsiveness to shareholders;
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Whether a takeover offer has been rebuffed;
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Whether minority or majority representation is being sought.
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When analyzing a contested election of directors, ISS will generally focus on two central questions: (1) Have the dissidents proved that board change is warranted? And (2) if so, are the
dissident board nominees likely to effect positive change (i.e., maximize long-term shareholder value).
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Discharge of Directors
Generally vote FOR the discharge of directors, including members of the management board and/or supervisory board,
unless
there is reliable
information about significant and compelling controversies that the board is not fulfilling its fiduciary duties warranted by:
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A lack of oversight or actions by board members which invoke shareholder distrust related to malfeasance or poor supervision, such as operating in
private or company interest rather than in shareholder interest; or
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Any legal issues (e.g. civil/criminal) aiming to hold the board responsible for breach of trust in the past or related to currently alleged actions yet
to be confirmed (and not only the fiscal year in question), such as price fixing, insider trading, bribery, fraud, and other illegal actions; or
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Other egregious governance issues where shareholders will bring legal action against the company or its directors.
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For markets which do not routinely request discharge resolutions (e.g. common law countries or markets where discharge is not mandatory), analysts may
voice concern in other appropriate agenda items, such as approval of the annual accounts or other relevant resolutions, to enable shareholders to express discontent with the board.
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Vote proposals seeking indemnification and liability protection for directors and officers on a CASE-BY-CASE basis.
Vote AGAINST proposals to indemnify external auditors.
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Vote FOR proposals to fix board size.
Vote AGAINST the introduction of classified boards and
mandatory retirement ages for directors.
Vote AGAINST proposals to alter board structure or size in the context of a fight for control of the
company or the board.
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3.
CAPITAL STRUCTURE
Share Issuance Requests
General Issuances
Vote FOR issuance requests with
preemptive rights to a maximum of 100 percent over currently issued capital.
Vote FOR issuance requests without preemptive rights to a
maximum of 20 percent of currently issued capital.
Specific Issuances
Vote on a CASE-BY-CASE basis on all requests, with or without preemptive rights.
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Increases in Authorized Capital
Vote FOR non-specific proposals to increase authorized capital up to 100 percent over the current authorization unless the increase would leave the company with less than 30 percent of its new
authorization outstanding.
Vote FOR specific proposals to increase authorized capital to any amount, unless:
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The specific purpose of the increase (such as a share-based acquisition or merger) does not meet ISS guidelines for the purpose being proposed; or
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The increase would leave the company with less than 30 percent of its new authorization outstanding after adjusting for all proposed issuances.
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Vote AGAINST proposals to adopt unlimited capital authorizations.
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Vote FOR proposals to reduce capital for routine accounting purposes unless the terms are unfavorable to shareholders.
Vote proposals to reduce capital in connection with corporate restructuring on a CASE-BY-CASE basis.
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Capital Structures
Vote FOR resolutions that seek to maintain or convert to a one-share, one-vote capital structure.
Vote AGAINST requests for the creation or continuation of dual-class capital structures or the creation of new or additional super voting shares.
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Preferred
Stock
Vote FOR the creation of a new class of preferred stock or for issuances of preferred stock up to 50 percent of issued capital
unless the terms of the preferred stock would adversely affect the rights of existing shareholders.
Vote FOR the creation/issuance of
convertible preferred stock as long as the maximum number of common shares that could be issued upon conversion meets ISS guidelines on equity issuance requests.
Vote AGAINST the creation of a new class of preference shares that would carry superior voting rights to the common shares.
Vote AGAINST the creation of blank check preferred stock unless the board clearly states that the authorization will not be used to thwart a takeover bid.
Vote proposals to increase blank check preferred authorizations on a CASE-BY-CASE basis.
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Debt Issuance Requests
Vote non-convertible debt issuance requests on a CASE-BY-CASE basis, with or without preemptive rights.
Vote FOR the creation/issuance of convertible debt instruments as long as the maximum number of common shares that could be issued upon conversion meets ISS guidelines on equity issuance requests.
Vote FOR proposals to restructure existing debt arrangements unless the terms of the restructuring would adversely affect the rights of
shareholders.
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Pledging of Assets for Debt
Vote proposals to approve the pledging of assets for debt on a CASE-BY-CASE basis.
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Increase in Borrowing Powers
Vote proposals to approve increases in a companys borrowing powers on a CASE-BY-CASE basis.
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Generally vote FOR market repurchase authorities (share repurchase programs) if the terms comply with the following criteria:
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A repurchase limit of up to 10 percent of outstanding issued share capital (15 percent in U.K./Ireland);
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A holding limit of up to 10 percent of a companys issued share capital in treasury (on the shelf); and
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A duration of no more than five years, or such lower threshold as may be set by applicable law, regulation or code of governance best practice.
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ISS 2012 International Proxy Voting Summary Guidelines
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B-181
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Authorities to repurchase shares in
excess of the 10 percent repurchase limit will be assessed on a case-by-case basis. ISS may support such share repurchase authorities under special circumstances, which are required to be publicly disclosed by the company, provided that, on balance,
the proposal is in shareholders interests. In such cases, the authority must comply with the following criteria:
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A holding limit of up to 10 percent of a companys issued share capital in treasury (on the shelf); and
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A duration of no more than 18 months.
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In markets where it is normal practice not to provide a repurchase limit, ISS will evaluate the proposal based on the companys historical practice. However, ISS expects companies to disclose such
limits and, in the future, may recommend a vote against companies that fail to do so. In such cases, the authority must comply with the following criteria:
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A holding limit of up to 10 percent of a companys issued share capital in treasury (on the shelf); and
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A duration of no more than 18 months.
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In addition, ISS will recommend AGAINST any proposal where:
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The repurchase can be used for takeover defenses;
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There is clear evidence of abuse;
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There is no safeguard against selective buybacks; and/or
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Pricing provisions and safeguards are deemed to be unreasonable in light of market practice.
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u
u
u
u
u
Reissuance of Repurchased Shares
Vote FOR requests to reissue any repurchased shares unless there is clear evidence of abuse of this authority in the past.
u
u
u
u
u
Capitalization of Reserves for Bonus Issues/Increase in Par Value
Vote FOR requests to capitalize reserves for bonus issues of shares or to increase par value.
u
u
u
u
u
4. COMPENSATION
Compensation Plans
Vote compensation plans on a CASE-BY-CASE
basis.
u
u
u
u
u
Director Compensation
Vote FOR proposals to award cash fees to non-executive directors unless the amounts are excessive relative to other companies in the country or industry.
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ISS 2012 International Proxy Voting Summary Guidelines
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B-182
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Vote non-executive director compensation
proposals that include both cash and share-based components on a CASE-BY-CASE basis.
Vote proposals that bundle compensation for both
non-executive and executive directors into a single resolution on a CASE-BY-CASE basis.
Vote AGAINST proposals to introduce retirement
benefits for non-executive directors.
u
u
u
u
u
5. OTHER ITEMS
Reorganizations/Restructurings
Vote reorganizations and
restructurings on a CASE-BY-CASE basis.
u
u
u
u
u
Mergers and Acquisitions
Vote CASE-BY-CASE on mergers and acquisitions taking into account the following:
For every
M&A analysis, ISS reviews publicly available information as of the date of the report and evaluates the merits and drawbacks of the proposed transaction, balancing various and sometimes countervailing factors including:
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ValuationIs the value to be received by the target shareholders (or paid by the acquirer) reasonable? While the fairness opinion may provide an
initial starting point for assessing valuation reasonableness, ISS places emphasis on the offer premium, market reaction, and strategic rationale.
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Market reactionHow has the market responded to the proposed deal? A negative market reaction will cause ISS to scrutinize a deal more closely.
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Strategic rationaleDoes the deal make sense strategically? From where is the value derived? Cost and revenue synergies should not be overly
aggressive or optimistic, but reasonably achievable. Management should also have a favorable track record of successful integration of historical acquisitions.
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Conflicts of interestAre insiders benefiting from the transaction disproportionately and inappropriately as compared to non-insider shareholders?
ISS will consider whether any special interests may have influenced these directors and officers to support or recommend the merger.
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GovernanceWill the combined company have a better or worse governance profile than the current governance profiles of the respective parties to
the transaction? If the governance profile is to change for the worse, the burden is on the company to prove that other issues (such as valuation) outweigh any deterioration in governance.
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Vote AGAINST if the companies do not provide sufficient information upon request to make an informed voting decision.
u
u
u
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u
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ISS 2012 International Proxy Voting Summary Guidelines
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B-183
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Mandatory
Takeover Bid Waivers
Vote proposals to waive mandatory takeover bid requirements on a CASE-BY-CASE basis.
u
u
u
u
u
Reincorporation Proposals
Vote reincorporation proposals on a CASE-BY-CASE basis.
u
u
u
u
u
Expansion of Business Activities
Vote FOR resolutions to expand business activities unless the new business takes the company into risky areas.
u
u
u
u
u
Related-Party Transactions
In evaluating resolutions that seek shareholder approval on related-party transactions (RPTs), vote on a case-by-case basis, considering factors including, but not limited to, the following:
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The parties on either side of the transaction;
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The nature of the asset to be transferred/service to be provided;
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The pricing of the transaction (and any associated professional valuation);
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The views of independent directors (where provided);
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The views of an independent financial adviser (where appointed);
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Whether any entities party to the transaction (including advisers) is conflicted; and
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The stated rationale for the transaction, including discussions of timing.
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If there is a transaction that ISS deemed problematic and that was not put to a shareholder vote, ISS may recommend against the election of the director involved in the related-party transaction or the
full board.
u
u
u
u
u
Antitakeover Mechanisms
Generally vote AGAINST all antitakeover proposals, unless they are structured in such a way that they give shareholders the ultimate decision on any proposal or offer.
u
u
u
u
u
Shareholder Proposals
Vote all shareholder proposals on a CASE-BY-CASE basis.
Vote FOR proposals that would improve
the companys corporate governance or business profile at a reasonable cost.
Vote AGAINST proposals that limit the companys
business activities or capabilities or result in significant costs being incurred with little or no benefit.
u
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u
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u
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ISS 2012 International Proxy Voting Summary Guidelines
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DISCLOSURE/DISCLAIMER
This document and all of the information contained in it, including without limitation all text, data, graphs, and charts (collectively, the Information) is the property of Institutional
Shareholder Services Inc. (ISS), its subsidiaries, or, in some cases third party suppliers.
The Information has not been
submitted to, nor received approval from, the United States Securities and Exchange Commission or any other regulatory body. None of the Information constitutes an offer to sell (or a solicitation of an offer to buy), or a promotion or
recommendation of, any security, financial product or other investment vehicle or any trading strategy, and ISS does not endorse, approve or otherwise express any opinion regarding any issuer, securities, financial products or instruments or trading
strategies.
The user of the Information assumes the entire risk of any use it may make or permit to be made of the Information.
ISS MAKES NO EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS WITH RESPECT TO THE INFORMATION AND EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING,
WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS, NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION.
Without limiting any of the foregoing and to the maximum extent permitted by law, in no event shall ISS have any liability regarding any of the
Information for any direct, indirect, special, punitive, consequential (including lost profits) or any other damages even if notified of the possibility of such damages. The foregoing shall not exclude or limit any liability that may not by
applicable law be excluded or limited.
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ISS 2012 International Proxy Voting Summary Guidelines
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B-185
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2012 Japan Proxy Voting Summary Guidelines
December 19, 2011
Institutional Shareholder
Services Inc.
Copyright
©
2011 by ISS
www.issgovernance.com
186
ISS 2012 Japan
Proxy Voting Summary Guidelines
Effective for Meetings on or after Feb. 1, 2012
Published Dec. 19, 2011
Table of Contents
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-187
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-188
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1.
Approval of Financial Statements
Vote FOR approval of financial statements, unless:
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External auditor expressed no opinion, or raised concerns; or
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Statutory auditors/audit committee raised concerns; or
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There are concerns about the financial statements presented or audit procedures used.
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Summary
Most companies around the world
submit these reports to shareholders for approval. However in Japan, this item usually will not be put to a shareholder vote, but will only be presented as a reporting item as allowed under disclosure regulations. Accordingly, shareholders should be
cautious if this item is on agenda items because that would mean that special circumstances emerge thereby requiring companies to seek shareholder approval. For instance, the item could be proposed because the auditors were unable to finish auditing
in time for the audit report to be included in the proxy circular, or raised questions about the financial statements. In those cases, a detailed case-by-case analysis will apply.
2. Income Allocation
Vote FOR approval of income allocation,
unless:
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Payout ratio is consistently low without adequate justification; or
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Payout ratio is too high, potentially damaging financial health.
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Summary
In the past, the first voting resolution at nearly all Japanese AGMs was approval
of the allocation of income and the final dividend for the year under review. However, companies that have amended their articles to authorize the board to determine income allocation are no longer required to seek shareholder approval of the income
allocation. Likewise, companies that are not paying a dividend will also have no income allocation proposals.
As long as the dividend payout
ratio is within a range of 15 percent to 100 percent, we generally support this resolution. If the payout ratio does not fall in this range, ISS will evaluate this resolution on a case-by-case basis. Particular attention will be paid to cases where
a company proposes to pay a dividend exceeding its net profit, as such payments could damage the companys long-term financial health.
3. Election of Directors
ISS has two policies for director elections in Japan: one for companies with a statutory auditor board structure, and the other for companies with a U.S.-type three committee structure. Regardless of
governance structure, Vote FOR the election of directors, except for:
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A top
executive
1
if the board after the shareholder meeting does
not include at least one outsider, regardless of independence (This new provision of the policy will be fully implemented at all Japanese companies beginning in 2013); or
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1.
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In most cases, the top executive will be the shacho (president). However, there are companies where the ultimate decision-making authority
rests with the kaicho (executive chairman) or daihyo torishimariyaku (representative director).
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-189
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A top executive at a company that has a controlling shareholder, where the board after the shareholder meeting does not include at least two
independent directors based on ISS independence criteria for Japan; or
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An outside director nominee who attended less than 75 percent of board meetings during the year under review
2
; or
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A top executive who is responsible for not implementing a shareholder proposal which has received a majority of votes cast, or not putting a similar
proposal on the ballot as a management proposal the following year (with a management recommendation of FOR), when that proposal is deemed to be in the interest of independent shareholders.
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In addition, at companies with a U.S.-type three committee structure, Vote FOR the election of directors, unless:
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The outside director nominee is regarded as non-independent based on ISS independence criteria for Japan, and the board after the shareholder meeting
is not majority independent; or
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Where a company has a controlling shareholder, the director nominee who sits on the nomination committee and is an insider, or non-independent
outsider, when the board after the shareholder meeting does not include at least two independent directors based on ISS independence criteria for Japan.
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Regardless of governance structure, under extraordinary circumstances, vote AGAINST individual directors, members of a committee, or the entire board, due to:
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Material failures of governance, stewardship, risk oversight, or fiduciary responsibilities at the company; or
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Failure to replace management as appropriate; or
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Egregious actions related to a directors service on other boards that raise substantial doubt about his or her ability to effectively oversee
management and serve the best interests of shareholders at any company.
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Independence
criteria for Japan
Those outside director candidates falling into any of the following categories should be regarded as non-independent.
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Individuals who work or worked at major shareholders of the company in question;
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Individuals who work or worked at main lenders/banks to the company in question;
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Individuals who work or worked at the lead underwriter(s) of the company in question;
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Individuals who work or worked at business partners of the company in question and the transaction value is material from the recipients
perspective or is not disclosed;
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Individuals who worked at the companys audit firm;
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Individuals who offer or offered professional services such as legal advice, financial advice, tax advice or consulting services to the company in
question; or
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Individuals who have a relative(s) working at the company in question.
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2.
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The attendance of inside directors is not disclosed in Japan.
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-190
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Summary
Unlike U.S. boards, most Japanese boards are essentially executive committees and play a minimal role in management oversight. At companies with a
statutory auditor structure (which account for about 98 percent of public Japanese companies), there is no legal requirement that boards have outside directors. About half of Japanese companies still do not have any outsiders. However, companies
with a U.S.-type three committee structure are required by law to have at least two outside directors.
Corporate Japan has long been
criticized for lack of outside oversight, let alone independence. Global comparison of board independence shows that Japanese boards lag far behind foreign counterparts, and it was customary for Japanese boards to be composed entirely of insiders.
Nevertheless, the situation has changed, albeit slowly, over the years, and it was during 2010 when more than half of Japanese companies (regardless of board structure) came to have at least one outsider for the first time (50.4 percent, based on
ISS data). For companies covered by ISS in 2011, where director elections were proposed, the number slightly increased to 51.0 percent.
Given
that a majority of Japanese boards already have at least one outsider, and in light of regulatory development reflecting changing public awareness toward the importance of board independence, having outsiders on boards is no longer considered an
alien concept among the Japanese business community, corporations, and institutional shareholders. Furthermore, reflecting recent corporate scandals (Olympus and Daio Paper), the argument for increasing board supervision is now being called for more
urgently than ever.
Outsiders at companies with a statutory auditor system
The new policy provision (opposing a companys top executive if the board does not include at least one outside director) at companies with a statutory auditor system reflects that changing
environment, but will not be implemented until 2013. This one-year moratorium is intended to give companies sufficient time to recruit qualified outside director candidates.
Unlike companies with a three committee structure, there are no requirements to set up nomination committees at companies with a statutory auditor system, which should be held formally responsible for the
director nomination process. In the absence of such requirements, the top executive is usually the final decision maker regarding the director nominee selection process at companies with a statutory auditor system. Therefore, it is reasonable to
oppose a top executive for concerns about board composition.
As of December 2011, Japans Ministry of Justice is considering requiring
Japanese listed companies to appoint at least one outside director on boards. However, because of strong opposition from issuers, there is no guarantee that such a requirement will be incorporated into practice. Even if it were to be required, it
would still take a few years before enforcement. As regulatory changes are expected to be made, ISS will revisit this policy accordingly.
Affiliated outsiders at companies with a statutory auditor system
Some shareholders may oppose outside director nominees, at companies with a statutory auditor system, whose independence is questionable in order to send a message to the board that companies should
appoint independent outsiders. However, such votes could backfire, as companies may instead be discouraged from appointing outside directors altogether because there are no requirements to appoint outsiders. If this were the case, boards could end
up with all insiders, which will not be in the interests of shareholders. Accordingly, ISS does not oppose outside directors simply because of the lack of independence at companies with a statutory auditor system.
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-191
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Companies with a three committee
structure
Where a company adopts the so-called U.S.-type three committee structure, the role of outside directors becomes critical, and an
emphasis on the independence of those directors is appropriate. Such companies are required to appoint at least two outside directors. Therefore, ISS opposes outside director nominees who do not meet our criteria for independence, unless the board
after the shareholder meeting is majority independent.
Controlled companies
ISS opposes the reelection of the top executive at any company that has controlling shareholders, if the board after the shareholder meeting does not include at least two independent directors. This
policy is intended to protect the interests of minority shareholders.
Furthermore, if a company with a three committee structure has
controlling shareholders, ISS also recommends voting against the reappointment of nomination committee members who are insiders or affiliated outsiders, unless the board after the shareholder meeting includes at least two independent directors.
Those committee members should be held responsible for the lack of independence.
Attendance
We believe that effective management oversight can be realized by having independent board members who actively participate in board deliberations. As
such, we pay attention to attendance rates. If an outside director attends fewer than 75 percent of board meetings, without a reasonable excuse, ISS will generally recommend a vote against that directors reelection.
Poor performance and corporate scandal
ISS also considers recommending votes against nominees for clear mismanagement, as manifested in egregiously poor stock and financial performance or corporate scandals, including fraudulent or criminal
activity, which led to shareholder value destruction. Factors we evaluate to that end include financial impact, administrative orders by regulators, stock market reaction, as well as reputational damage.
Shareholder-unfriendly behavior
We factor in shareholder-unfriendly behavior in evaluating director election proposals. Such behavior may include the introduction of a poison pill without a shareholder vote, or a capital strategy
leading to shareholder value destruction such as a dilutive third-party placement without a shareholder vote, as well as large-scale public offerings without convincing rationales.
4. Election of Statutory Auditors
Vote FOR election of
statutory auditors, unless:
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The outside statutory auditor nominee is regarded as non-independent based on ISS independence criteria for Japan
3
; or
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The outside statutory nominee attended less than 75 percent of meetings of the board of directors or board of statutory auditors during the year under
review; or
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3.
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ISS uses the same independence criteria for directors and statutory auditors. See Election of Directors.
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-192
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The statutory auditor is judged to be responsible for clear mismanagement or shareholder-unfriendly behavior.
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Summary
ISS believes that management
oversight by independent statutory auditors is crucial to ensure that companies have better governance. Japans Corporate Law allows companies to choose between two governance structures: a statutory auditor system, and a U.S.-type three
committee system. About 98 percent of Japanese public companies employ a statutory auditor system, and for those companies, there is no legal requirement that boards have outside directors. Based on Japanese meetings, covered by ISS during 2011,
where director elections were proposed, 50.3 percent of companies with a statutory auditor system do not have any outsiders. At these companies, the board of directors essentially functions as an executive committee and plays a minimal role in
management oversight, which is instead left to the board of statutory auditors.
Given the frequent lack of independent outside directors at
Japanese companies, it is critically important to have independent outside statutory auditors. Therefore, ISS opposes any outside statutory auditor nominees who do not meet our criteria for independence. If outside nominees are voted down, companies
need to appoint other outside candidates because the law requires that at least half of a companys statutory auditors be designated as outside statutory auditors. Because the law requires that the statutory auditor board be composed of at
least three members, companies need to have at least two outside statutory auditors to meet the legal requirement.
As in the case of outside
directors, we pay attention to attendance rates. If an outside statutory auditor attends fewer than 75 percent of meetings of the board of directors or board of statutory auditors, without a reasonable excuse, ISS will generally recommend a vote
against that statutory auditors reelection. In addition, ISS considers recommending votes against statutory auditor nominees in cases of corporate scandals, including fraudulent or criminal activity, which have led to shareholder value
destruction.
5. Article Amendments
Amendments are nearly always bundled together as a single voting resolution, and ISS general approach is to oppose article amendments as a whole when they include changes we oppose. The following
are some of the most common or significant types of changes to articles.
Expansion of business activities
Vote FOR this change, unless:
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A company has performed poorly for several years and seeks business expansion into a risky enterprise unrelated to its core business.
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Adoption of a U.S.-style three committee board structure
Vote FOR this change, unless:
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None of the outside director candidates meets ISS criteria on independence
4
.
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4.
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See Election of Directors for ISS criteria on independence.
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-193
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Increase
in authorized capital
Vote CASE-BY-CASE on this request if the company explicitly provides reasons for the increase. Otherwise, Vote FOR
this change, unless:
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The increase in authorized capital exceeds 100 percent of the currently authorized capital; or
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The increase leaves the company with less than 30 percent of the proposed authorized capital outstanding; or
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The increase is intended for a poison pill, which ISS opposes.
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Creation/modification of preferred shares/class shares
Vote
CASE-BY-CASE on this request
Repurchase of shares at boards discretion
Vote AGAINST this change.
Allow company to make rules governing exercise of shareholders rights
Vote AGAINST this change.
Amendments related to takeover defenses
Vote FOR this change, unless:
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ISS opposes or has opposed the poison pill proposal by itself.
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Decrease in maximum board size
Vote FOR this change, unless:
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The decrease eliminates all vacant seats, leaving no flexibility to add shareholder nominees or other outsiders to the board without removing an
incumbent director.
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Supermajority vote requirement to remove a director
Vote AGAINST this change.
Reduce directors term in office from two years to one year
Vote FOR this change.
Limitations of liability for directors/statutory auditors
Vote FOR this change.
Limitations of liability for external
auditors
Vote AGAINST this change.
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-194
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Payment
of dividends at the boards discretion
Vote AGAINST this change.
MBO-related amendments
Vote CASE-BY-CASE on this request.
Summary
The governance
profile of a Japanese company is largely stipulated in its articles of incorporation. Requests for amendments cover various issues ranging from capital increases and changes to capital structures, to changes to board size and composition. Takeover
defense-related changes are often included in articles as well. Once the articles are amended to authorize a company to carry out a specific action, shareholders will usually have no opportunities to vote on such action in the future. Therefore,
these resolutions require scrutiny. This is particularly true under the Corporate Law, enacted in 2006, which is largely designed to give more authority to boards than under the old Commercial Code, on condition that shareholders approve changes to
articles of incorporation.
6. Annual Bonuses for Directors/Statutory Auditors
Vote FOR approval of annual bonuses, unless:
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Recipients include those who are judged to be responsible for clear mismanagement or shareholder-unfriendly behavior.
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Summary
Companies usually make annual
bonus payments without shareholder approval as there are no legal requirements requiring companies to seek shareholder approval before making such payments. Accordingly, seeking shareholder approval itself should be viewed as a positive practice. In
addition, the amounts are rarely excessive, and therefore, ISS usually supports the proposal. However, when companies suffer from poor financial and stock performance, or have experienced corporate scandals, ISS will consider recommending a vote
against the proposals.
7. Retirement Bonuses/Special Payments in Connection with Abolition of Retirement
Bonus System
Retirement Bonuses
Vote FOR approval of retirement bonuses, unless:
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Recipients include outsiders
5
; or
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Neither the individual payments nor the aggregate amount of the payments is disclosed; or
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Recipients include those who are judged to be responsible for clear mismanagement or shareholder-unfriendly behavior.
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5.
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However, in rare occasions, ISS may support payment to outsiders on a case-by-case basis, if the individual amount is disclosed and the amount is not
excessive.
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-195
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Special
Payments in Connection with Abolition of Retirement Bonus System
Vote FOR approval of special payments in connection with abolition of
retirement bonus system, unless:
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Recipients include outsiders
6
; or
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Neither the individual payments nor the aggregate amount of the payments is disclosed; or
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Recipients include those who are judged to be responsible for clear mismanagement or shareholder-unfriendly behavior.
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Summary
The expectation of receiving a
retirement bonus can serve as a disincentive for outside directors or statutory auditors to speak out against management. Accordingly, ISS opposes the payment of retirement bonuses to outsiders. In addition, if neither the individual payments nor
the aggregate amount of the payments is disclosed, we oppose the payments. Furthermore, we do not believe it is appropriate to grant retirement benefits to those who can be held responsible for shareholder value destruction resulting from corporate
scandals or poor financial performance.
8. Stock Option Plans/Deep-Discounted Stock Option Plans
Stock Option Plans
Vote FOR approval of stock option plans, unless:
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Total dilution from proposed plan(s) and previous option plans exceeds 5 percent for mature companies, or 10 percent for growth companies; or;
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Recipients include individuals who are not in a position to affect the companys stock price, including employees of business partners or
unspecified collaborators; or
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The maximum number of options that can be issued per year is not disclosed.
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Deep-Discounted Stock Option Plans
Vote FOR approval of
deep-discounted stock option plans, unless:
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Total dilution from proposed plan(s) and previous option plans exceeds 5 percent for mature companies, or 10 percent for growth companies; or
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Recipients include individuals who are not in a position to affect the companys stock price, including employees of business partners or
unspecified collaborators; or
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The maximum number of options that can be issued per year is not disclosed; or
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No specific performance hurdles are specified (However, if the vesting period before exercise lasts for at least three years, this policy may not
apply).
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Summary
As the number of agenda items at Japanese companies has declined in recent years, compensation-related proposals have increased in relative importance. This is particularly true of stock options, which
can be beneficial
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-196
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or disadvantageous to independent shareholders, depending on the plan design. ISS will evaluate stock options mainly in terms of potential dilution, option recipients, exercise period, exercise
price, and performance hurdles (if any).
While dilution is an important factor in evaluating options, Japanese companies dilution,
particularly at large companies, has been modest. As such, this is seldom an issue. On the other hand, in order to align the interests of option recipients with those of independent shareholders, we believe that some mechanism to that end will be
called for. We will pay attention to whether performance hurdles are disclosed in the proposal details.
9.
Director Compensation Celing
Vote FOR proposals seeking to increase director fees, if:
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The specific reason(s) for the increase are explained; or
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The company is introducing or increasing a ceiling for performance-based compensation.
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Vote CASE-BY-CASE on proposals seeking to increase director fees, taking into account the companys stock price performance and capital efficiency
if:
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The proposals are intended to increase fixed cash compensation or do not specify whether it is fixed or performance-based compensation which will be
increased.
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Generally vote AGAINST proposals seeking to increase director fees if there are serious concerns about corporate
malfeasance.
Summary
The
problem with Japanese pay is not the amount, but the lack of it linking to shareholder wealth creation. Cash salaries and cash retirement bonuses, neither of which is directly linked to performance, constitute a significant portion of Japanese
executives compensation. On the other hand, performance-based pay occupies a relatively small portion of total pay. Furthermore, equity-based incentives, notably stock options, still are not popular among Japanese executives.
Japanese companies are now required to disclose individual director pay, where total compensation exceeds JPY 100 million ($1.3 million), in their
Yuho securities filings (equivalent of the 10K for U.S. companies). According to the Nikkei newspaper, there were 295 executives, of about 2,600 companies closing their books in March 2011, whose total pay exceeded JPY 100 million. The highest paid
executive was Nissan Motor CEO and Chairman Carlos Ghosn whose total pay was JPY 982 million, followed by Sony CEO and Chairman Howard Stringer who received JPY 863 million in total. The data shows that of the aggregate pay for those 295
executives, three-fourths is fixed compensation (cash salaries and cash retirement bonuses) and the remaining one-fourth is performance-based pay (performance-based cash compensation and equity-based incentives).
ISS policy (which was updated for 2012) is intended to promote the use of performance-based compensation. ISS generally will support proposals
calling for an increase in the director compensation ceiling if the increase is intended to introduce/increase the performance-based pay component. However, if proposals are seeking an increase in non-performance based director pay or it is unclear
whether director pay is performance-based, ISS will examine capital efficiency of the company in question, notably the return on equity (ROE) trend, and the total shareholder return to determine whether management has conducted business from
shareholders perspectives.
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-197
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10.
Statutory Auditor Compensation Ceiling
Vote FOR proposals seeking to increase statutory auditor compensation ceiling, unless:
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Statutory auditors are judged to be responsible for clear mismanagement or shareholder-unfriendly behavior.
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11. Audit Firm Appointments
Vote FOR the appointment of audit firms, unless:
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There are serious concerns related to changing auditors.
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Summary
In Japan, appointment of external audit firms will be put to a shareholder vote
only when companies seek to appoint new audit firms. Auditors term is one year, and the same auditors can be reappointed without shareholder approval. In addition, audit firm rotations are not mandated by regulations. Accordingly, unlike in
the U.S., this item is not among frequent voting items at Japanese companies.
12. Share Repurchase Plans
Vote FOR the share repurchase plans, unless:
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The proposed repurchase plan exceeds 10 percent of issued share capital without explanation; or
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There are serious concerns about a possible adverse impact on shareholder value.
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13. Takeover Defense Plans (Poison Pills)
Vote FOR approval of takeover defense plans (poison pills), unless:
(Necessary conditions)
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The board does not include at least 20 percent (but no fewer than two) independent directors
7
after the shareholder meeting; or
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These independent directors fail to meet ISS guidelines on board meeting attendance
8
; or
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The directors are not subject to annual election; or
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One or more members of the bid evaluation committee cannot be regarded as independent based on ISS criteria for independence; or
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The trigger threshold is set less than 20 percent of shares outstanding; or
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The duration of the poison pill exceeds three years; or
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There are other protective or entrenchment tools that can serve as takeover defenses; including blocking stakes held by management-friendly
shareholders, or setting the maximum board size to the actual board size to eliminate vacant seats, or tightening of procedures for removing a director from office; or
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7.
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See Election of Directors for ISS criteria on independence.
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8.
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See Election of Directors for ISS criteria on board meeting attendance.
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-198
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The company fails to release its proxy circular at least three weeks prior to the meeting, to give shareholders sufficient time to study the details of
the proposal and question management about them.
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(Second stage of analysis)
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The company has not disclosed what specific steps it is taking to address the vulnerability to a takeover by enhancing shareholder value.
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Summary
ISS recognizes that there may be circumstances in which a well-designed poison pill may strengthen the boards negotiating position and allow it to
obtain more favorable terms from an acquirer. However, this scenario only applies when the target companys board is more concerned with shareholder value than with protecting its own position. In order for ISS to be able to support a poison
pill in Japan, the above-mentioned conditions will have to be met. Interestingly, most companies which have failed to release proxy circulars at least three weeks before the meeting also failed at least one other criterion as well, implying that how
early companies release their proxy materials is an excellent way to measure overall shareholder-friendliness.
ISS evaluates all poison pill
proposals on a case-by-case basis, but our guidelines specify a number of necessary conditions which must all be met before we can even consider supporting a takeover defense. In the relatively few cases in which each of these necessary conditions
is met, ISS will proceed to the second stage of the analysis, which is to assess the companys plans to enhance value. The implementation of a poison pill is an admission that the board sees the company as vulnerable to a takeover, so
shareholders will need to see a plan to increase the share price, not merely a plan to entrench an underperforming management team.
Notwithstanding management fears, some of the companies implementing pills are in fact not especially vulnerable, because founding families, business
partners, or other insiders own more than a third of outstanding shares. This is enough to veto any special resolution, such as an article amendment or a merger meaning that even if a hostile bidder is able to accumulate a sizable stake in
such a company, that bidder will be unable to force any major restructuring moves opposed by the insiders. It is difficult to see what shareholders of such a company stand to gain from a poison pill.
Importantly, the primary problem at Japanese companies is not the terms of the poison pills themselves these are often superior to those of U.S.
companies due to features such as relatively high trigger thresholds, clear sunset provisions and an absence of dead hand provisions. Rather, the main problem is with Japanese companies insider-dominated boards and insufficient
disclosure. We believe that the presence of a critical mass of independent directors is essential in order to ensure that a takeover defense is used not merely to entrench management, but to contribute to the enhancement of shareholder value.
Where a company has implemented a takeover defense without shareholder approval, and that defense allows the board to block the bid without
input from shareholders, ISS will consider opposing the reelection of the representative director(s). This decision will depend on the terms of the defense plan itself, the companys overall governance profile (including board composition and
information disclosure practices), and the companys performance under the current management team.
In evaluating poison pill renewals,
we will apply the same necessary conditions we apply to new pills. At the same time, we will examine the companys share price performance, relative to its peers, since the pill was first put in place. Where the company has underperformed the
market, it will be difficult to argue that shareholders have benefited from the pill, or that they should support its renewal.
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-199
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14.
Mergers & Acquisitions, Third-Party Share Issuances (Private Placements)
Vote CASE-BY-CASE on M&As and Third-Party Placements
taking into account the following:
For every M&A and Third-Party Placement analysis, ISS reviews publicly available information as of the
date of the report and evaluates the merits and drawbacks of the proposed transaction, balancing various and sometimes countervailing factors including:
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Valuation Is the value to be received by the target shareholders (or paid by the acquirer) reasonable?
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Market reaction How has the market responded to the proposed deal? A negative market reaction will cause ISS to scrutinize a deal more closely.
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Strategic rationale Does the deal make sense strategically? From where is the value derived? Cost and revenue synergies should not be overly
aggressive or optimistic, but reasonably achievable. Management should also have a favorable track record of successful integration of historical acquisitions.
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Conflicts of interest Are insiders benefiting from the transaction disproportionately and inappropriately as compared to non-insider
shareholders? ISS will consider whether any special interests may have influenced these directors and officers to support or recommend the merger.
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Governance Will the combined company have a better or worse governance profile than the current governance profiles of the respective parties to
the transaction? If the governance profile is to change for the worse, the burden is on the company to prove that other issues (such as valuation) outweigh any deterioration in governance.
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15. Shareholder Proposals
Vote all shareholder proposals on a CASE-BY-CASE basis.
Vote FOR proposals that would improve
the companys corporate governance or business profile at a reasonable cost.
Vote AGAINST proposals that limit the companys
business activities or capabilities or result in significant costs being incurred with little or no benefit.
u
u
u
u
u
Disclosure/Disclaimer
This document and all of the information contained in it, including without limitation all text, data, graphs, and charts (collectively, the Information) is the property of Institutional
Shareholder Services Inc. (ISS), its subsidiaries, or, in some cases third party suppliers.
The Information has not been
submitted to, nor received approval from, the United States Securities and Exchange Commission or any other regulatory body. None of the Information constitutes an offer to sell (or a solicitation of an offer to buy), or a promotion or
recommendation of, any security, financial product or other investment vehicle or any trading strategy, and ISS does not endorse, approve or otherwise express any opinion regarding any issuer, securities, financial products or instruments or trading
strategies.
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-200
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The user of the Information assumes the
entire risk of any use it may make or permit to be made of the Information.
ISS MAKES NO EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS
WITH RESPECT TO THE INFORMATION AND EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING, WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS, NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY AND FITNESS FOR A PARTICULAR
PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION.
Without limiting any of the foregoing and to the maximum extent permitted by law, in no
event shall ISS have any liability regarding any of the Information for any direct, indirect, special, punitive, consequential (including lost profits) or any other damages even if notified of the possibility of such damages. The foregoing shall not
exclude or limit any liability that may not by applicable law be excluded or limited.
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ISS 2012 Japan Proxy Voting Summary Guidelines
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B-201
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PART C
OTHER INFORMATION
Unless otherwise noted, all
references are to the Registrants initial registration statement on Form N-1A (the Registration Statement) as filed with the Securities and Exchange Commission (SEC) on October 21, 1991 (File Nos. 33-43446 and
811-06444).
(a)
(1) The Registrants Declaration of Trust dated as of October 2, 2006 is incorporated herein by reference to Post-Effective Amendment No. 70 as filed with the SEC on April 16, 2007 (Post-Effective Amendment
No. 70).
(2) The Registrants Declaration of Trust dated as of October 2, 2006 as amended and restated as
of August 18, 2011 is incorporated herein by reference to Post-Effective Amendment No. 213 as filed with the SEC on August 22, 2011 (Post-Effective Amendment No. 213).
(3) Designation of Series of Shares of Beneficial Interests in the Trust effective as of February 8, 2007 is incorporated herein by
reference to Post-Effective Amendment No. 70.
(4) Amended and Restated Designation of Series of Shares of Beneficial
Interests in the Trust effective as of August 9, 2007 is incorporated herein by reference to Post-Effective Amendment No. 72 as filed with the SEC on August 24, 2007 (Post-Effective Amendment No. 72).
(5) Amended and Restated Designation of Classes effective as of August 9, 2007 is incorporated herein by reference to Post-Effective
Amendment No. 72.
(6) Amended and Restated Designation of Series of Shares of Beneficial Interests in the Trust and
Amended and Restated Designation of Classes effective as of November 8, 2007 is incorporated herein by reference to Post-Effective Amendment No. 76 as filed with the SEC on November 30, 2007 (Post-Effective Amendment
No. 76).
(7) Amended and Restated Designation of Series of Shares of Beneficial Interests in the Trust effective as
of February 7, 2008 is incorporated herein by reference to Post-Effective Amendment No. 87 as filed with the SEC on February 15, 2008 (Post-Effective Amendment No. 87).
(8) Amended and Restated Designation of Classes effective as of February 7, 2008 is incorporated herein by reference to
Post-Effective Amendment No. 87.
(9) Amended and Restated Designation of Series of Shares of Beneficial Interests in the
Trust effective as of May 8, 2008 is incorporated herein by reference to Post-Effective Amendment No. 109 as filed with the SEC on June 3, 2008 (Post-Effective Amendment No. 109).
(10) Amended and Restated Designation of Classes effective as of May 8, 2008 is incorporated herein by reference to Post-Effective
Amendment No. 109.
(11) Amended and Restated Designation of Series of Shares of Beneficial Interests in the Trust
effective as of June 6, 2008 is incorporated herein by reference to Post-Effective Amendment No. 110 as filed with the SEC on June 6, 2008 (Post-Effective Amendment No. 110).
(12) Amended and Restated Designation of Classes effective as of June 6, 2008 is incorporated herein by reference to Post-Effective
Amendment No. 110.
(13) Amended and Restated Designation of Series of Shares of Beneficial Interests in the Trust
effective as of January 28, 2009 is incorporated herein by reference to Post-Effective Amendment No. 133 as filed with the SEC on January 28, 2009 (Post-Effective Amendment No. 133).
(14) Amended and Restated Designation of Classes effective as of January 28, 2009 is incorporated herein by reference to
Post-Effective Amendment No. 133.
(15) Amended and Restated Designation of Classes effective as of February 26, 2009
is incorporated herein by reference to Post-Effective Amendment No. 137 as filed with the SEC on February 27, 2009 (Post-Effective Amendment No. 137).
(16) Amended and Restated Designation of Classes effective as of February 26, 2009 is
incorporated herein by reference to Post-Effective Amendment No. 146 as filed with the SEC on June 25, 2009 (Post-Effective Amendment No. 146).
(17) Amended and Restated Designation of Series of Shares of Beneficial Interests in the Trust effective as of August 5, 2009 is incorporated herein by reference to Post-Effective Amendment
No. 150 as filed with the SEC on November 6, 2009 (Post-Effective Amendment No. 150).
(18) Amended
and Restated Designation of Classes effective as of August 5, 2009 is incorporated herein by reference to Post-Effective Amendment No. 150.
(19) Amended and Restated Designation of Series of Shares of Beneficial Interest in the Trust effective as of December 7, 2009 is incorporated herein by reference to Post-Effective Amendment
No. 159 as filed with the SEC on February 16, 2010 (Post-Effective Amendment No. 159).
(20) Amended
and Restated Designation of Classes effective as of December 7, 2009 is incorporated herein by reference to Post-Effective Amendment No. 159.
(21) Amended and Restated Designation of Series of Shares of Beneficial Interest in the Trust effective as of February 4, 2010 is incorporated herein by reference to Post-Effective Amendment
No. 162 as filed with the SEC on March 15, 2010 (Post-Effective Amendment No. 162).
(22) Amended
and Restated Designation of Classes effective as of February 4, 2010 is incorporated herein by reference to Post-Effective Amendment No. 162.
(23) Amended and Restated Designation of Series of Shares of Beneficial Interest in the Trust effective as of May 6, 2010 is incorporated herein by reference to Post-Effective Amendment No. 171
as filed with the SEC on June 4, 2010 (Post-Effective Amendment No. 171).
(24) Amended and Restated
Designation of Classes effective as of May 6, 2010 is incorporated herein by reference to Post-Effective Amendment No. 171.
(25) Amended and Restated Designation of Series of Shares of Beneficial Interests in the Trust effective as of May 6, 2010 is incorporated herein by reference to Post-Effective Amendment No. 172
as filed with the SEC on June 16, 2010 (Post-Effective Amendment No. 172).
(26) Amended and Restated
Designation of Classes effective as of May 6, 2010 is incorporated herein by reference to Post-Effective Amendment No. 172.
(27) Amended and Restated Designation of Series of Shares of Beneficial Interest in the Trust effective as of June 15, 2010 is incorporated herein by reference to Post-Effective Amendment
No. 173 as filed with the SEC on July 28, 2010 (Post-Effective Amendment No. 173).
(28) Amended and
Restated Designation of Classes effective as of June 15, 2010 is incorporated herein by reference to Post-Effective Amendment No. 173.
(29) Amended and Restated Designation of Series of Shares of Beneficial Interest in the Trust is incorporated herein by reference to Post-Effective Amendment No. 179 as filed with the SEC on
December 29, 2010 (Post-Effective Amendment No. 179).
(30) Amended and Restated Designation of Classes
effective as of November 4, 2010 is incorporated herein by reference to Exhibit 1(bb) to the Registration Statement on Form N-14 of Legg Mason Partners Equity Trust as filed with the SEC on November 19, 2010.
(31) Amended and Restated Designation of Series of Shares of Beneficial Interest in the Trust effective as of January 17, 2012 is
incorporated herein by reference to Post-Effective Amendment No. 218 as filed with the SEC on January 25, 2012 (Post-Effective Amendment No. 218).
(32) Amended and Restated Designation of Classes effective as of January 17, 2012 is incorporated herein by reference to Post-Effective Amendment No. 218.
(33) Amended and Restated Designation of Series of Shares of Beneficial Interest in the Trust effective as of April 13, 2012 is
incorporated herein by reference to Post-Effective Amendment No. 230 as filed with the SEC on April 13, 2012 (Post-Effective Amendment No. 230).
- 4 -
(34) Amended and Restated Designation of Classes effective as of April 13, 2012 is
incorporated herein by reference to Post-Effective Amendment No. 230.
(35) Amended and Restated Designation of Classes
effective as of August 1, 2012 is incorporated herein by reference to Post-Effective Amendment No. 243 as filed with the SEC on August 23, 2012.
(36) Amended and Restated Designation of Series of Shares of Beneficial Interest in the Trust effective as of September 12, 2012 is incorporated herein by reference to Post-Effective Amendment
No. 246 as filed with the SEC on September 12, 2012 (Post-Effective Amendment No. 246).
(37)
Amended and Restated Designation of Classes effective as of September 12, 2012 is incorporated herein by reference to Post-Effective Amendment No. 246.
(38) Amended and Restated Designation of Series effective as of October 1, 2012 is incorporated herein by reference to Post-Effective Amendment No. 249 as filed with the SEC on November 30,
2012 (Post-Effective Amendment No. 249).
(39) Amended and Restated Designation of Series dated
November 28, 2012 is incorporated herein by reference to Post-Effective Amendment No. 249.
(40) Amended and Restated
Designation of Classes dated November 28, 2012 is incorporated herein by reference to Post-Effective Amendment No. 249.
(b)(1) The Registrants By-Laws dated October 4, 2006 are incorporated herein by reference to Post-Effective Amendment No. 70.
(2) The Registrants By-Laws dated October 4, 2006 as amended and restated as of August 18, 2011 are
incorporated herein by reference to Post-Effective Amendment No. 213.
(c) Not Applicable.
(d) (1) Form of Management Agreement between the Registrant, on behalf of Legg Mason ClearBridge Aggressive Growth Fund (formerly
known as Legg Mason Partners Aggressive Growth Fund), and Legg Mason Partners Fund Advisor, LLC (LMPFA) is incorporated herein by reference to Post-Effective Amendment No. 78 as filed with the SEC on December 14, 2007
(Post-Effective Amendment No. 78).
(2) Form of Management Agreement between the Registrant, on behalf of Legg
Mason ClearBridge Tactical Dividend Income Fund (formerly known as Legg Mason ClearBridge Diversified Large Cap Growth Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(3) Form of Management Agreement between the Registrant, on behalf of Legg Mason ClearBridge Dividend Strategy Fund (formerly known as
Legg Mason Partners Dividend Strategy Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(4) Form of Management Agreement between the Registrant, on behalf of Legg Mason Esemplia Emerging Markets Equity Fund (formerly known as Legg Mason Partners Emerging Markets Equity Fund), and LMPFA is
incorporated herein by reference to Post-Effective Amendment No. 78.
(5) Form of Management Agreement between the
Registrant, on behalf of Legg Mason Investment Counsel Financial Services Fund (formerly known as Legg Mason Barrett Financial Services Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(6) Form of Management Agreement between the Registrant, on behalf of Legg Mason ClearBridge Fundamental All Cap Value Fund (formerly
known as Legg Mason ClearBridge Fundamental Value Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(7) Form of Management Agreement between the Registrant, on behalf of Legg Mason Global Currents International All Cap Opportunity Fund (formerly known as Legg Mason Partners International All Cap
Opportunity Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(8) Form of
Management Agreement between the Registrant, on behalf of Legg Mason Capital Management All Cap Fund (formerly known as Legg Mason Partners All Cap Fund), and Legg Mason Capital Management Inc. (LMCM) is incorporated herein by reference
to Post-Effective Amendment No. 73 as filed with the SEC on August 27, 2007 (Post-Effective Amendment No. 73).
- 5 -
(9) Form of Management Agreement between the Registrant, on behalf of Legg Mason ClearBridge
Small Cap Value Fund (formerly known as Legg Mason Partners Small Cap Value Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(10) Form of Management Agreement between the Registrant, on behalf of Legg Mason ClearBridge Appreciation Fund (formerly known as Legg Mason Partners Appreciation Fund), and LMPFA is incorporated herein
by reference to Post-Effective Amendment No. 78.
(11) Form of Management Agreement between the Registrant, on behalf of
Legg Mason ClearBridge Equity Income Builder Fund (formerly known as Legg Mason ClearBridge Capital and Income Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(12) Form of Management Agreement between the Registrant, on behalf of Legg Mason ClearBridge Capital Fund (formerly known as Legg Mason
Partners Capital Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(13) Form of
Management Agreement between the Registrant, on behalf of Legg Mason ClearBridge Equity Fund (formerly known as Legg Mason Partners Equity Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(14) Form of Management Agreement between the Registrant, on behalf of Legg Mason Batterymarch Global Equity Fund (formerly known as Legg
Mason Partners Global Equity Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 73.
(15) Form of Management Agreement between the Registrant, on behalf of Legg Mason ClearBridge Large Cap Value Fund (formerly known as Legg
Mason ClearBridge Investors Value Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(16) Form of Management Agreement between the Registrant, on behalf of Legg Mason ClearBridge Large Cap Growth Fund (formerly known as
Legg Mason Partners Large Cap Growth Fund) and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(17) Form of Management Agreement between the Registrant, on behalf of Legg Mason Lifestyle Allocation 100% (formerly known as Legg Mason Partners Lifestyle Allocation 100%), and LMPFA is incorporated
herein by reference to Post-Effective Amendment No. 73.
(18) Form of Amended Management Agreement between the Registrant,
on behalf of Legg Mason Lifestyle Allocation 100% (formerly known as Legg Mason Partners Lifestyle Allocation 100%), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 95 as filed with the SEC on April 4, 2008
(Post-Effective Amendment No. 95).
(19) Form of Management Agreement between the Registrant, on behalf of
Legg Mason Lifestyle Allocation 30% (formerly known as Legg Mason Partners Lifestyle Allocation 30%), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(20) Form of Amended Management Agreement between the Registrant, on behalf of Legg Mason Lifestyle Allocation 30% (formerly known as Legg
Mason Partners Lifestyle Allocation 30%), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 95.
(21) Form of Management Agreement between the Registrant, on behalf of Legg Mason Lifestyle Allocation 50% (formerly known as Legg Mason
Partners Lifestyle Allocation 50%), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(22) Form of Amended Management Agreement between the Registrant, on behalf of Legg Mason Lifestyle Allocation 50% (formerly known as Legg
Mason Partners Lifestyle Allocation 50%), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 95.
(23) Form of Management Agreement between the Registrant, on behalf of Legg Mason Lifestyle Allocation 70% (formerly known as Legg Mason
Partners Lifestyle Allocation 70%), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(24) Form of Amended Management Agreement between the Registrant, on behalf of Legg Mason Lifestyle Allocation 70% (formerly known as Legg
Mason Partners Lifestyle Allocation 70%), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 95.
- 6 -
(25) Form of Management Agreement between the Registrant, on behalf of Legg Mason Lifestyle
Allocation 85% (formerly known as Legg Mason Partners Lifestyle Allocation 85%), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(26) Form of Amended Management Agreement between the Registrant, on behalf of Legg Mason Lifestyle Allocation 85% (formerly known as Legg Mason Partners Lifestyle Allocation 85%), and LMPFA is
incorporated herein by reference to Post-Effective Amendment No. 95.
(27) Form of Management Agreement between the
Registrant, on behalf of Legg Mason Lifestyle Income Fund (formerly known as Legg Mason Partners Lifestyle Income Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(28) Form of Amended Management Agreement between the Registrant, on behalf of Legg Mason Lifestyle Income Fund (formerly known as Legg
Mason Partners Lifestyle Income Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 95.
(29) Form of Management Agreement between the Registrant, on behalf of Legg Mason ClearBridge Mid Cap Core Fund (formerly known as Legg
Mason Partners Mid Cap Core Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(30)
Form of Management Agreement between the Registrant, on behalf of Legg Mason Batterymarch S&P 500 Index Fund (formerly known as Legg Mason Partners S&P 500 Index Fund), and LMPFA is incorporated herein by reference to Post-Effective
Amendment No. 78.
(31) Form of Management Agreement between the Registrant, on behalf of Legg Mason ClearBridge Small Cap
Growth Fund (formerly known as Legg Mason Partners Small Cap Growth Fund), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 78.
(32) Form of Management Agreement between the Registrant, on behalf of Legg Mason Investment Counsel Social Awareness Fund (formerly known as Legg Mason Partners Social Awareness Fund), and LMPFA is
incorporated herein by reference to Post-Effective Amendment No. 78.
(33) Form of Management Agreement between the
Registrant, on behalf of Legg Mason Batterymarch U.S. Large Cap Equity Fund (formerly known as Legg Mason Partners U.S. Large Cap Equity Fund), and LMPFA is incorporated herein by reference from Post-Effective Amendment No. 87.
(34) Form of Management Agreement between the Registrant, on behalf of Legg Mason Target Retirement 2015 (formerly known as Legg Mason
Partners Target Retirement 2015), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 120 as filed with the SEC on August 28, 2008 (Post-Effective Amendment No. 120).
(35) Form of Management Agreement between the Registrant, on behalf of Legg Mason Target Retirement 2020 (formerly known as Legg Mason
Partners Target Retirement 2020), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 120.
(36)
Form of Management Agreement between the Registrant, on behalf of Legg Mason Target Retirement 2025 (formerly known as Legg Mason Partners Target Retirement 2025), and LMPFA is incorporated herein by reference to Post-Effective Amendment
No. 120.
(37) Form of Management Agreement between the Registrant, on behalf of Legg Mason Target Retirement 2030
(formerly known as Legg Mason Partners Target Retirement 2030), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 120.
(38) Form of Management Agreement between the Registrant, on behalf of Legg Mason Target Retirement 2035 (formerly known as Legg Mason Partners Target Retirement 2035), and LMPFA is incorporated herein by
reference to Post-Effective Amendment No. 120.
(39) Form of Management Agreement between the Registrant, on behalf of
Legg Mason Target Retirement 2040 (formerly known as Legg Mason Partners Target Retirement 2040), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 120.
(40) Form of Management Agreement between the Registrant, on behalf of Legg Mason Target Retirement 2045 (formerly known as Legg Mason
Partners Target Retirement 2045), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 120.
- 7 -
(41) Form of Management Agreement between the Registrant, on behalf of Legg Mason Target
Retirement 2050 (formerly known as Legg Mason Partners Target Retirement 2050), and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 120.
(42) Form of Management Agreement between the Registrant, on behalf of Legg Mason Target Retirement Fund (formerly known as Legg Mason Partners Target Retirement Fund), and LMPFA is incorporated herein by
reference to Post-Effective Amendment No. 120.
(43) Form of Management Agreement between the Registrant, on behalf of
Legg Mason Permal Tactical Allocation Fund, and LMPFA is incorporated herein by reference to Post-Effective Amendment No. 141 as filed with the SEC on April 9, 2009 (Post-Effective Amendment No. 141).
(44) Form of Management Agreement between the Registrant, on behalf of Legg Mason ClearBridge Mid Cap Growth Fund, and LMPFA, is
incorporated herein by reference to Post-Effective Amendment No. 177 as filed with the SEC on August 31, 2010 (Post-Effective Amendment No. 177).
(45) Form of Management Agreement between the Registrant, on behalf of Legg Mason Global Currents International Small Cap Opportunity Fund, and LMPFA, is incorporated herein by reference to Post-Effective
Amendment No. 178 as filed with the SEC on September 29, 2010 (Post-Effective Amendment No. 178).
(46) Form of Management Agreement between the Registrant, on behalf of Legg Mason Dynamic Multi-Strategy Fund, and LMPFA, is incorporated
herein by reference to Post-Effective Amendment No. 238 as filed with the SEC on June 25, 2012 (Post-Effective Amendment No. 238).
(47) Form of Management Agreement between the Registrant, on behalf of ClearBridge Select Fund, and LMPFA, is incorporated herein by reference to Post-Effective Amendment No. 249.
(48) Form of Management Agreement between the Registrant, on behalf of Legg Mason Batterymarch Managed Volatility International Dividend
Fund, and LMPFA, to be filed by amendment.
(49) Form of Management Agreement between the Registrant, on behalf of Legg Mason
Batterymarch Managed Volatility Global Dividend Fund, and LMPFA, to be filed by amendment.
(50) Form of Subadvisory Agreement
between LMPFA and ClearBridge Advisors, LLC (ClearBridge), with respect to Legg Mason ClearBridge Aggressive Growth Fund (formerly known as Legg Mason Partners Aggressive Growth Fund), is incorporated herein by reference to
Post-Effective Amendment No. 78.
(51) Form of Subadvisory Agreement between LMPFA and ClearBridge, with respect to Legg
Mason ClearBridge Tactical Dividend Income Fund (formerly known as Legg Mason ClearBridge Diversified Large Cap Growth Fund), is incorporated herein by reference to Post-Effective Amendment No. 78.
(52) Form of Subadvisory Agreement between LMPFA and ClearBridge, with respect to Legg Mason ClearBridge Dividend Strategy Fund (formerly
known as Legg Mason Partners Dividend Strategy Fund), is incorporated herein by reference to Post-Effective Amendment No. 78.
(53) Form of Subadvisory Agreement between LMPFA and Legg Mason International Equities Limited (LMIE), with respect to Legg Mason Esemplia Emerging Markets Equity Fund (formerly known as Legg
Mason Partners Emerging Markets Equity Fund), is incorporated herein by reference to Post-Effective Amendment No. 78.
(54) Form of Subadvisory Agreement between LMPFA and Legg Mason Investment Counsel, LLC (LMIC), with respect to Legg Mason
Investment Counsel Financial Services Fund (formerly known as Legg Mason Barrett Financial Services Fund) is incorporated herein by reference to Post-Effective Amendment No. 73.
(55) Form of Subadvisory Agreement between LMPFA and ClearBridge, with respect to Legg Mason ClearBridge Fundamental All Cap Value Fund
(formerly known as Legg Mason ClearBridge Fundamental Value Fund), is incorporated herein by reference to Post-Effective Amendment No. 78.
(56) Form of Subadvisory Agreement between LMPFA and ClearBridge, with respect to Legg Mason ClearBridge Small Cap Value Fund (formerly known as Legg Mason Partners Small Cap Value Fund), is incorporated
herein by reference to Post-Effective Amendment No. 78.
- 8 -
(57) Form of Subadvisory Agreement between LMPFA and ClearBridge, with respect to Legg Mason
ClearBridge Appreciation Fund (formerly known as Legg Mason Partners Appreciation Fund), is incorporated herein by reference to Post-Effective Amendment No. 78.
(58) Form of Subadvisory Agreement between LMPFA and ClearBridge, with respect to Legg Mason ClearBridge Equity Income Builder Fund (formerly known as Legg Mason ClearBridge Capital and Income Fund), is
incorporated herein by reference to Post-Effective Amendment No. 78.
(59) Form of Subadvisory Agreement between LMPFA and
ClearBridge, with respect to Legg Mason ClearBridge Capital Fund (formerly known as Legg Mason Partners Capital Fund), is incorporated herein by reference to Post-Effective Amendment No. 78.
(60) Form of Subadvisory Agreement between LMPFA and ClearBridge, with respect to Legg Mason ClearBridge Equity Fund (formerly known as
Legg Mason Partners Equity Fund), is incorporated herein by reference to Post-Effective Amendment No. 78.
(61) Form of
Subadvisory Agreement between LMPFA and Batterymarch Financial Management, Inc. (Batterymarch), with respect to Legg Mason Batterymarch Global Equity Fund (formerly known as Legg Mason Partners Global Equity Fund), is incorporated herein
by reference to Post-Effective Amendment No. 73.
(62) Form of Subadvisory Agreement between LMPFA and ClearBridge, with
respect to Legg Mason ClearBridge Large Cap Value Fund (formerly known as Legg Mason ClearBridge Investors Value Fund), is incorporated herein by reference to Post-Effective Amendment No. 78.
(63) Form of Subadvisory Agreement between LMPFA and ClearBridge, with respect to Legg Mason ClearBridge Large Cap Growth Fund (formerly
known as Legg Mason Partners Large Cap Growth Fund), is incorporated herein by reference to Post-Effective Amendment No. 78.
(64) Form of Subadvisory Agreement between LMPFA and Legg Mason Global Asset Allocation, LLC (LMGAA), with respect to Legg Mason Lifestyle Allocation 100% (formerly known as Legg Mason
Partners Lifestyle Allocation 100%), is incorporated herein by reference to Post-Effective Amendment No. 74 as filed with the SEC on November 1, 2007 (Post-Effective Amendment No. 74).
(65) Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to Legg Mason Lifestyle Allocation 30% (formerly known as Legg
Mason Partners Lifestyle Allocation 30%), is incorporated herein by reference to Post-Effective Amendment No. 74.
(66)
Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to Legg Mason Lifestyle Allocation 50% (formerly known as Legg Mason Partners Lifestyle Allocation 50%), is incorporated herein by reference to Post-Effective Amendment No. 74.
(67) Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to Legg Mason Lifestyle Allocation 70% (formerly
known as Legg Mason Partners Lifestyle Allocation 70%), is incorporated herein by reference to Post-Effective Amendment No. 74.
(68) Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to Legg Mason Lifestyle Allocation 85% (formerly known as Legg Mason Partners Lifestyle Allocation 85%), is incorporated herein by
reference to Post-Effective Amendment No. 74.
(69) Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to
Legg Mason Lifestyle Income Fund (formerly known as Legg Mason Partners Lifestyle Income Fund), is incorporated herein by reference to Post-Effective Amendment No. 74.
(70) Form of Subadvisory Agreement between LMPFA and ClearBridge, with respect to Legg Mason ClearBridge Mid Cap Core Fund (formerly known as Legg Mason Partners Mid Cap Core Fund), is incorporated herein
by reference to Post-Effective Amendment No. 78.
(71) Form of Subadvisory Agreement between LMPFA and Batterymarch, with
respect to Legg Mason Batterymarch S&P 500 Index Fund (formerly known as Legg Mason Partners S&P 500 Index Fund), is incorporated herein by reference to Post-Effective Amendment No. 78.
(72) Form of Subadvisory Agreement between LMPFA and ClearBridge, with respect to Legg Mason ClearBridge Small Cap Growth Fund (formerly
known as Legg Mason Partners Small Cap Growth Fund), is incorporated herein by reference to Post-Effective Amendment No. 78.
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(73) Form of Subadvisory Agreement between LMPFA and LMIC, with respect to Legg Mason
Investment Counsel Social Awareness Fund (formerly known as Legg Mason Partners Social Awareness Fund), is incorporated herein by reference to Post-Effective Amendment No. 73.
(74) Form of Subadvisory Agreement between LMPFA and Batterymarch, with respect to Legg Mason Batterymarch U.S. Large Cap Equity Fund
(formerly known as Legg Mason Partners U.S. Large Cap Equity Fund), is incorporated herein by reference to Post-Effective Amendment No. 87.
(75) Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to Legg Mason Target Retirement 2015 (formerly known as Legg Mason Partners Target Retirement 2015), is incorporated herein by
reference to Post-Effective Amendment No. 120.
(76) Form of Subadvisory Agreement between LMPFA and LMGAA, with respect
to Legg Mason Target Retirement 2020 (formerly known as Legg Mason Partners Target Retirement 2020), is incorporated herein by reference to Post-Effective Amendment No. 120.
(77) Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to Legg Mason Target Retirement 2025 (formerly known as Legg
Mason Partners Target Retirement 2025), is incorporated herein by reference to Post-Effective Amendment No. 120.
(78)
Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to Legg Mason Target Retirement 2030 (formerly known as Legg Mason Partners Target Retirement 2030), is incorporated herein by reference to Post-Effective Amendment No. 120.
(79) Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to Legg Mason Target Retirement 2035 (formerly known
as Legg Mason Partners Target Retirement 2035), is incorporated herein by reference to Post-Effective Amendment No. 120.
(80) Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to Legg Mason Target Retirement 2040 (formerly known as Legg
Mason Partners Target Retirement 2040), is incorporated herein by reference to Post-Effective Amendment No. 120.
(81)
Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to Legg Mason Target Retirement 2045 (formerly known as Legg Mason Partners Target Retirement 2045), is incorporated herein by reference to Post-Effective Amendment No. 120.
(82) Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to Legg Mason Target Retirement 2050 (formerly known
as Legg Mason Partners Target Retirement 2050), is incorporated herein by reference to Post-Effective Amendment No. 120.
(83) Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to Legg Mason Target Retirement Fund (formerly known as Legg
Mason Partners Target Retirement Fund), is incorporated herein by reference to Post-Effective Amendment No. 120.
(84)
Form of Subadvisory Agreement between LMPFA and Global Currents Investment Management, LLC (GCIM), with respect to Legg Mason Global Currents International All Cap Opportunity Fund (formerly known as Legg Mason Partners International All
Cap Opportunity Fund), is incorporated herein by reference to Post-Effective Amendment No. 126 as filed with the SEC on November 26, 2008.
(85) Form of Subadvisory Agreement between LMPFA and Permal Asset Management Inc. (Permal), with respect to Legg Mason Permal Tactical Allocation Fund is incorporated herein by reference to
Post-Effective Amendment No. 141.
(86) Form of Subadvisory Agreement between LMPFA and LMGAA, with respect to Legg Mason
Permal Tactical Allocation Fund is incorporated herein by reference to Post-Effective Amendment No. 141.
(87) Form of
Sub-Administration Agreement between LMCM and LMPFA, with respect to Legg Mason Capital Management All Cap Fund (formerly known as Legg Mason Partners All Cap Fund), is incorporated herein by reference to Post-Effective Amendment No. 76.
(88) Form of Subadvisory Agreement between LMPFA and ClearBridge, with respect to Legg Mason ClearBridge Mid Cap Growth Fund,
is incorporated herein by reference to Post-Effective Amendment No. 177.
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(89) Form of Subadvisory Agreement between LMPFA and GCIM, with respect to Legg Mason Global
Currents International Small Cap Opportunity Fund, is incorporated herein by reference to Post-Effective Amendment No. 178.
(90) Form of Subadvisory Agreement between LMPFA and LMIC, with respect to Legg Mason Investment Counsel Financial Services Fund (formerly
known as Legg Mason Barrett Financial Services Fund), is incorporated herein by reference to Post-Effective Amendment No. 175 as filed with the SEC on August 25, 2010 (Post-Effective Amendment No. 175).
(91) Form of Subadvisory Agreement between LMPFA and Western Asset Management Company (WAM), regarding Legg Mason Batterymarch
Global Equity Fund, dated February 2, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215 as filed with the SEC on December 16, 2011 (Post-Effective Amendment No. 215).
(92) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Batterymarch U.S. Large Cap Equity Fund, dated
February 2, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(93) Form of Subadvisory
Agreement between LMPFA and WAM, regarding Legg Mason Batterymarch S&P 500 Index Fund, dated November 4, 2010, is incorporated herein by reference to Post-Effective Amendment No. 215.
(94) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason ClearBridge Aggressive Growth Fund, dated November 4,
2010, is incorporated herein by reference to Post-Effective Amendment No. 215.
(95) Form of Subadvisory Agreement between
LMPFA and WAM, regarding Legg Mason ClearBridge Appreciation Fund, dated February 2, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(96) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason ClearBridge Capital Fund, dated February 2, 2011, is incorporated herein by reference to Post-Effective Amendment
No. 215.
(97) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason ClearBridge Tactical Dividend
Income Fund (formerly known as Legg Mason ClearBridge Diversified Large Cap Growth Fund), dated February 2, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(98) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason ClearBridge Dividend Strategy Fund, dated February 2,
2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(99) Form of Subadvisory Agreement between
LMPFA and WAM, regarding Legg Mason ClearBridge Equity Fund, dated February 2, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(100) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason ClearBridge Equity Income Builder Fund, dated February 2, 2011, is incorporated herein by reference to Post-Effective
Amendment No. 215.
(101) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason ClearBridge
Fundamental All Cap Value Fund, dated November 4, 2010, is incorporated herein by reference to Post-Effective Amendment No. 215.
(102) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason ClearBridge Large Cap Growth Fund, dated February 2, 2011, is incorporated herein by reference to Post-Effective
Amendment No. 215.
(103) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason ClearBridge Large Cap
Value Fund, dated February 2, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
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(104) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason ClearBridge
Mid Cap Core Fund, dated February 2, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(105) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason ClearBridge Mid Cap Growth Fund, dated February 2,
2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(106) Form of Subadvisory Agreement
between LMPFA and WAM, regarding Legg Mason ClearBridge Small Cap Growth Fund, dated February 2, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(107) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason ClearBridge Small Cap Value Fund, dated November 4,
2010, is incorporated herein by reference to Post-Effective Amendment No. 215.
(108) Form of Subadvisory Agreement
between LMPFA and WAM, regarding Legg Mason Esemplia Emerging Markets Equity Fund, dated February 2, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(109) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Global Currents International All Cap Opportunity Fund,
dated February 2, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(110) Form of
Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Global Currents International Small Cap Opportunity Fund, dated May 5, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(111) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Lifestyle Allocation 50%, dated May 5, 2011, is
incorporated herein by reference to Post-Effective Amendment No. 215.
(112) Form of Subadvisory Agreement between LMPFA
and WAM, regarding Legg Mason Lifestyle Allocation 70%, dated May 5, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(113) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Lifestyle Allocation 85%, dated May 5, 2011, is incorporated herein by reference to Post-Effective Amendment
No. 215.
(114) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Lifestyle Allocation 100%, dated
May 5, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(115) Form of Subadvisory
Agreement between LMPFA and WAM, regarding Legg Mason Permal Tactical Allocation Fund, dated February 2, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(116) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Target Retirement 2015, dated May 5, 2011, is
incorporated herein by reference to Post-Effective Amendment No. 215.
(117) Form of Subadvisory Agreement between LMPFA
and WAM, regarding Legg Mason Target Retirement 2020, dated May 5, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(118) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Target Retirement 2025, dated May 5, 2011, is incorporated herein by reference to Post-Effective Amendment
No. 215.
(119) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Target Retirement 2030, dated
May 5, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
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(120) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Target
Retirement 2035, dated May 5, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(121)
Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Target Retirement 2040, dated May 5, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(122) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Target Retirement 2045, dated May 5, 2011, is
incorporated herein by reference to Post-Effective Amendment No. 215.
(123) Form of Subadvisory Agreement between LMPFA
and WAM, regarding Legg Mason Target Retirement 2050, dated May 5, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(124) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Target Retirement Fund, dated May 5, 2011, is incorporated herein by reference to Post-Effective Amendment
No. 215.
(125) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Dynamic Multi-Strategy Fund is
incorporated herein by reference to Post-Effective Amendment No. 238.
(126) Form of Subadvisory Agreement between LMPFA
and LMGAA, regarding Legg Mason Dynamic Multi-Strategy Fund is incorporated herein by reference to Post-Effective Amendment No. 238.
(127) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Capital Management All Cap Fund, is incorporated herein by reference to Post-Effective Amendment No. 247 as filed with
the SEC on September 26, 2012.
(128) Form of Subadvisory Agreement between LMPFA and WAM, regarding ClearBridge Select
Fund is incorporated herein by reference to Post-Effective Amendment No. 249.
(129) Form of Subadvisory Agreement between
LMPFA and ClearBridge, regarding ClearBridge Select Fund is incorporated herein by reference to Post-Effective Amendment No. 249.
(130) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason Batterymarch Managed Volatility International Dividend Fund to be filed by amendment.
(131) Form of Subadvisory Agreement between LMPFA and ClearBridge, regarding Legg Mason Batterymarch Managed Volatility International
Dividend Fund to be filed by amendment.
(132) Form of Subadvisory Agreement between LMPFA and WAM, regarding Legg Mason
Batterymarch Managed Volatility Global Dividend Fund to be filed by amendment.
(133) Form of Subadvisory Agreement between
LMPFA and ClearBridge, regarding Legg Mason Batterymarch Managed Volatility Global Dividend Fund to be filed by amendment.
(e)
(1) Form of Distribution Agreement with Citigroup Global Markets Inc. (CGMI) is incorporated herein by reference to Post-Effective Amendment No. 30 as filed with the SEC on August 16, 2000 (Post-Effective Amendment
No. 30).
(2) Form of Distribution Agreement with PFS Distributors, Inc. is incorporated herein by reference to
Post-Effective Amendment No. 30.
(3) Form of Amendment to the Distribution Agreement with CGMI dated as of
December 1, 2005, is incorporated herein by reference to Post-Effective Amendment No. 56 as filed with the SEC on January 27, 2006 (Post-Effective Amendment No. 56).
(4) Form of Amendment of Distribution Agreement and Assumption of Duties and Responsibilities, among the Registrant, PFS Distributors,
Inc. and PFS Investments, Inc. (PFS), dated as of December 1, 2005, is incorporated herein by reference to Post-Effective Amendment No. 56.
(5) Letter Agreement amending the Distribution Agreements with CGMI dated April 10, 2007, is incorporated herein by reference to Post-Effective Amendment No. 76.
- 13 -
(6) Letter Agreement amending the Distribution Agreements with PFS dated April 6, 2007,
is incorporated herein by reference to Post-Effective Amendment No. 76.
(7) Form of Distribution Agreement with Legg
Mason Investor Services, LLC (LMIS) is incorporated herein by reference to Post-Effective Amendment No. 128, as filed with the SEC on December 15, 2008.
(8) Form of Distribution Agreement with LMIS, with respect to Legg Mason Permal Tactical Allocation Fund, is incorporated herein by reference to Post-Effective Amendment No. 141.
(9) Form of Distribution Agreement with LMIS, with respect to Legg Mason ClearBridge Mid Cap Growth Fund, is incorporated herein by
reference to Post-Effective Amendment No. 177.
(10) Form of Distribution Agreement with LMIS, with respect to Legg Mason
Global Currents International Small Cap Opportunity Fund, is incorporated herein by reference to Post-Effective Amendment No. 178.
(11) Form of Distribution Agreement with LMIS dated August 5, 2010 is incorporated herein by reference to Post-Effective Amendment No. 218.
(f) (1) Emeritus Retirement Plan relating to certain funds, established effective as of January 1, 2007, is incorporated herein
by reference to Post-Effective Amendment No. 60 as filed with the SEC on December 5, 2006 (Post-Effective Amendment No. 60).
(2) Amended and Restated Trustee Retirement Plan relating to certain funds dated as of January 1, 2005 (the General Retirement Plan), is incorporated herein by reference to Post-Effective
Amendment No. 61 as filed with the SEC on January 8, 2007 (Post-Effective Amendment No. 61).
(3)
Legg Mason Investment Series (f/k/a Smith Barney Investment Series) Amended and Restated Trustees Retirement Plan dated as of January 1, 2005, is incorporated herein by reference to Post-Effective Amendment No. 61.
(4) Amendment to the General Retirement Plan and the Legg Mason Partners Investment Series Amended and Restated Trustees Retirement Plan
is incorporated herein by reference to Post-Effective Amendment No. 61.
(5) Amended and Restated Emeritus Retirement Plan
relating to certain funds, established effective as of January 1, 2007, is incorporated herein by reference to Post-Effective Amendment No. 61.
(g) (1) Custodian Services Agreement with State Street Bank and Trust Company (State Street), dated October 5, 2012, is incorporated herein by reference to Post-Effective Amendment
No. 249.
(2) Fund Accounting Services Agreement with State Street, dated October 5, 2012, is incorporated herein by
reference to Post-Effective Amendment No. 249.
(3) Letter Agreement amending the Custodian Services Agreement and Fund
Accounting Services Agreement with State Street, effective as of November 30, 2012, is incorporated herein by reference to Post-Effective Amendment No. 249.
(h) (1) Transfer Agency and Services Agreement, dated January 1, 2006, between the Registrant and BNY Mellon Investment Servicing (US) Inc. (BNY) (formerly PNC Global Investment
Servicing (U.S.) Inc.) is incorporated herein by reference to Post-Effective Amendment No. 56.
(2) Co-Transfer Agency and
Services Agreement, dated April 1, 2009, between the Registrant and BNY incorporated herein by reference to Post-Effective Amendment No. 147 as filed with the SEC on July 29, 2009.
(3) Form of Letter Agreement amending the Co-Transfer Agency and Services Agreement, dated April 1, 2009, between the Registrant and
BNY is incorporated herein by reference to Post-Effective Amendment No. 238.
(4) Transfer Agency and Services Agreement,
dated April 4, 2009, between each series of the Registrant and Boston Financial Data Services, Inc. is incorporated herein by reference to Post-Effective Amendment No. 141.
- 14 -
(5) Form of Letter Agreement amending the Transfer Agency and Services Agreement, dated
April 4, 2009, between each series of the Registrant and Boston Financial Data Services, Inc. is incorporated herein by reference to Post-Effective Amendment No. 238.
(6) Form of Letter Agreement amending the Transfer Agency and Services Agreement, dated April 4, 2009, between each series of the Registrant and Boston Financial Data Services, Inc., dated
November 28, 2012 is incorporated herein by reference to Post-Effective Amendment No. 249.
(7) Form of License
Agreement between the Registrant and Legg Mason Properties, Inc. is incorporated herein by reference to Post-Effective Amendment No. 58 as filed with the SEC on April 28, 2006 (Post-Effective Amendment No. 58).
(8) License Agreement between the Registrant and Citigroup Inc. dated December 1, 2005 is incorporated herein by reference to
Post-Effective Amendment No. 58.
(9) Form of Fee Waiver and Expense Reimbursement Agreement is incorporated herein by
reference to Post-Effective Amendment No. 60.
(10) Letter Agreement amending the Transfer Agency and Services Agreement
with BNY, dated April 9, 2007, is incorporated herein by reference to Post-Effective Amendment No. 76.
(11) Form of
Fee Waiver and Expense Reimbursement Agreement with respect to Legg Mason Lifestyle Allocation 100% (formerly known as Legg Mason Partners Lifestyle Allocation 100%), Legg Mason Lifestyle Allocation 85% (formerly known as Legg Mason Partners
Lifestyle Allocation 85%), Legg Mason Lifestyle Allocation 70% (formerly known as Legg Mason Partners Lifestyle Allocation 70%), Legg Mason Lifestyle Allocation 50% (formerly known as Legg Mason Partners Lifestyle Allocation 50%), Legg Mason
Lifestyle Allocation 30% (formerly known as Legg Mason Partners Lifestyle Allocation 30%) and Legg Mason Lifestyle Income Fund (formerly known as Legg Mason Partners Lifestyle Income Fund) is incorporated herein by reference to Post-Effective
Amendment No. 95.
(12) Form of Fee Waiver and Expense Reimbursement Agreement, with respect to Legg Mason Target
Retirement 2015 (formerly known as Legg Mason Partners Target Retirement 2015), is incorporated herein by reference to Post-Effective Amendment No. 120.
(13) Form of Fee Waiver and Expense Reimbursement Agreement, with respect to Legg Mason Target Retirement 2020 (formerly known as Legg Mason Partners Target Retirement 2020), is incorporated herein by
reference to Post-Effective Amendment No. 120.
(14) Form of Fee Waiver and Expense Reimbursement Agreement, with respect
to Legg Mason Target Retirement 2025 (formerly known as Legg Mason Partners Target Retirement 2025), is incorporated herein by reference to Post-Effective Amendment No. 120.
(15) Form of Fee Waiver and Expense Reimbursement Agreement, with respect to Legg Mason Target Retirement 2030 (formerly known as Legg
Mason Partners Target Retirement 2030), is incorporated herein by reference to Post-Effective Amendment No. 120.
(16)
Form of Fee Waiver and Expense Reimbursement Agreement, with respect to Legg Mason Target Retirement 2035 (formerly known as Legg Mason Partners Target Retirement 2035), is incorporated herein by reference to Post-Effective Amendment No. 120.
(17) Form of Fee Waiver and Expense Reimbursement Agreement, with respect to Legg Mason Target Retirement 2040 (formerly known
as Legg Mason Partners Target Retirement 2040), is incorporated herein by reference to Post-Effective Amendment No. 120.
(18) Form of Fee Waiver and Expense Reimbursement Agreement, with respect to Legg Mason Target Retirement 2045 (formerly known as Legg
Mason Partners Target Retirement 2045), is incorporated herein by reference to Post-Effective Amendment No. 120.
(19)
Form of Fee Waiver and Expense Reimbursement Agreement, with respect to Legg Mason Target Retirement 2050 (formerly known as Legg Mason Partners Target Retirement 2050), is incorporated herein by reference to Post-Effective Amendment No. 120.
(20) Form of Fee Waiver and Expense Reimbursement Agreement, with respect to Legg Mason Target Retirement Fund (formerly known
as Legg Mason Partners Target Retirement Fund), is incorporated herein by reference to Post-Effective Amendment No. 120.
- 15 -
(21) Form of Fee Waiver and Expense Reimbursement Agreement, with respect to Legg Mason
Permal Tactical Allocation Fund is incorporated herein by reference to Post-Effective Amendment No. 141.
(22) Fee Waiver
and Expense Reimbursement Resolutions adopted by the Board of Trustees are incorporated herein by reference to Post-Effective Amendment No. 198 filed on April 26, 2011.
(23) Fee Waiver and Expense Reimbursement Resolutions adopted by the Board of Trustees with respect to Legg Mason Dynamic Multi-Strategy
Fund are incorporated herein by reference to Post-Effective Amendment No. 238.
(24) Fee Waiver and Expense Reimbursement
Resolutions adopted by the Board of Trustees with respect to ClearBridge Select Fund is incorporated herein by reference to Post-Effective Amendment No. 249.
(i) (1) Opinion of Counsel regarding legality of shares being registered is incorporated herein by reference to Pre-Effective Amendment No. 1 filed on December 6, 1991 (Pre-Effective
Amendment No. 1).
(2) Legal Counsels consent is incorporated herein by reference to Post-Effective Amendment
No. 24 as filed with the SEC on March 30, 1999 (Post-Effective Amendment No. 24).
(3) Opinion and
Consent of Counsel regarding the legality of shares being registered is incorporated herein by reference to Post-Effective Amendment No. 70.
(4) Opinion of Willkie Farr & Gallagher LLP regarding legality of Class FI and Class R shares of Legg Mason Lifestyle Allocation 100% (formerly known as Legg Mason Partners Lifestyle Allocation
100%), Legg Mason Lifestyle Allocation 85% (formerly known as Legg Mason Partners Lifestyle Allocation 85%), Legg Mason Lifestyle Allocation 70% (formerly known as Legg Mason Partners Lifestyle Allocation 70%), Legg Mason Lifestyle Allocation 50%
(formerly known as Legg Mason Partners Lifestyle Allocation 50%), Legg Mason Lifestyle Allocation 30% (formerly known as Legg Mason Partners Lifestyle Allocation 30%) and Legg Mason Lifestyle Income Fund (formerly known as Legg Mason Partners
Lifestyle Income Fund) is incorporated by reference to Post-Effective Amendment No. 75 filed on November 19, 2007 (Post-Effective Amendment No. 75).
(5) Opinion of Venable LLP regarding legality of Class FI and Class R shares of Legg Mason Lifestyle Allocation 100% (formerly known as Legg Mason Partners Lifestyle Allocation 100%), Legg Mason Lifestyle
Allocation 85% (formerly known as Legg Mason Partners Lifestyle Allocation 85%), Legg Mason Lifestyle Allocation 70% (formerly known as Legg Mason Partners Lifestyle Allocation 70%), Legg Mason Lifestyle Allocation 50% (formerly known as Legg Mason
Partners Lifestyle Allocation 50%), Legg Mason Lifestyle Allocation 30% (formerly known as Legg Mason Partners Lifestyle Allocation 30%) and Legg Mason Lifestyle Income Fund (formerly known as Legg Mason Partners Lifestyle Income Fund) is
incorporated by reference to Post-Effective Amendment No. 75.
(6) Opinion of Willkie Farr & Gallagher LLP
regarding legality of Class FI and Class R Shares of Legg Mason ClearBridge Fundamental All Cap Value Fund (formerly Legg Mason Partners Fundamental Value Fund) and Legg Mason ClearBridge Small Cap Value Fund (formerly Legg Mason Partners Small Cap
Value Fund) is incorporated by reference to Post-Effective Amendment No. 76.
(7) Opinion of Venable LLP regarding
legality of Class FI and Class R Shares of Legg Mason ClearBridge Fundamental All Cap Value Fund (formerly Legg Mason Partners Fundamental Value Fund) and Legg Mason ClearBridge Small Cap Value Fund (formerly Legg Mason Partners Small Cap Value
Fund) is incorporated by reference to Post-Effective Amendment No. 76.
(8) Opinion of Willkie Farr & Gallagher
LLP regarding legality of Class FI and Class R shares of Legg Mason ClearBridge Tactical Dividend Income Fund (formerly known as Legg Mason ClearBridge Diversified Large Cap Growth Fund), Legg Mason ClearBridge Dividend Strategy Fund (formerly known
as Legg Mason Partners Dividend Strategy Fund), Legg Mason Esemplia Emerging Markets Equity Fund (formerly known as Legg Mason Partners Emerging Markets Equity Fund) and Legg Mason Global Currents International All Cap Opportunity Fund (formerly
known as Legg Mason Partners International All Cap Opportunity Fund) is incorporated by reference to Post-Effective Amendment No. 78.
(9) Opinion of Venable LLP regarding legality of Class FI and Class R shares of Legg Mason ClearBridge Tactical Dividend Income Fund (formerly known as Legg Mason ClearBridge Diversified
- 16 -
Large Cap Growth Fund), Legg Mason ClearBridge Dividend Strategy Fund (formerly known as Legg Mason Partners Dividend Strategy Fund), Legg Mason Esemplia Emerging Markets Equity Fund (formerly
known as Legg Mason Partners Emerging Markets Equity Fund) and Legg Mason Global Currents International All Cap Opportunity Fund (formerly known as Legg Mason Partners International All Cap Opportunity Fund) is incorporated by reference to
Post-Effective Amendment No. 78.
(10) Opinion of Willkie Farr & Gallagher LLP regarding legality of Class FI and
Class R shares of Legg Mason ClearBridge Mid Cap Core Fund (formerly known as Legg Mason Partners Mid Cap Core Fund) is incorporated by reference to Post-Effective Amendment No. 79 as filed with the SEC on December 28, 2007
(Post-Effective Amendment No. 79).
(11) Opinion of Venable LLP regarding legality of Class FI and Class R
shares of Legg Mason ClearBridge Mid Cap Core Fund (formerly known as Legg Mason Partners Mid Cap Core Fund) is incorporated by reference to Post-Effective Amendment No. 79.
(12) Opinion of Willkie Farr & Gallagher LLP regarding legality of Class FI and Class R shares of Legg Mason Batterymarch Global
Equity Fund (formerly known as Legg Mason Partners Global Equity Fund) is incorporated by reference to Post-Effective Amendment No. 82 as filed with the SEC on February 5, 2008 (Post-Effective Amendment No. 82).
(13) Opinion of Venable LLP regarding legality of Class FI and Class R shares of Legg Mason Batterymarch Global Equity Fund
(formerly known as Legg Mason Partners Global Equity Fund) is incorporated by reference to Post-Effective Amendment No. 82.
(14) Opinion of Willkie Farr & Gallagher LLP regarding the legality of Class A, C, FI, R, I and IS shares of Legg Mason
Batterymarch U.S. Large Cap Equity Fund (formerly known as Legg Mason Partners U.S. Large Cap Equity Fund) is incorporated herein by reference to Post-Effective Amendment No. 87.
(15) Opinion of Venable LLP regarding the legality of Class A, C, FI, R, I and IS shares of Legg Mason Batterymarch U.S. Large Cap
Equity Fund (formerly known as Legg Mason Partners U.S. Large Cap Equity Fund) is incorporated herein by reference to Post-Effective Amendment No. 87.
(16) Opinion of Willkie Farr & Gallagher LLP regarding legality of Class IS shares of Legg Mason ClearBridge Appreciation Fund (formerly known as Legg Mason Partners Appreciation Fund), Class FI
and Class R Shares of Legg Mason ClearBridge Equity Income Builder Fund (formerly known as Legg Mason ClearBridge Capital and Income Fund), Class FI, Class R and Class IS shares of Legg Mason ClearBridge Capital Fund (formerly known as Legg Mason
Partners Capital Fund), Class FI and Class R shares of Legg Mason ClearBridge Equity Fund (formerly known as Legg Mason Partners Equity Fund), Class FI, Class R and Class IS shares of Legg Mason ClearBridge Large Cap Value Fund (formerly known as
Legg Mason Partners Investors Value Fund), Class IS shares of Legg Mason ClearBridge Small Cap Growth Fund (formerly Legg Mason Partners Small Cap Growth Fund) and Class FI and Class R shares of Legg Mason Investment Counsel Social Awareness Fund
(formerly known as Legg Mason Partners Social Awareness Fund) is incorporated by reference to Post-Effective Amendment No. 90 is incorporated by reference to Post-Effective Amendment No. 90 as filed with the SEC on February 26, 2008
(Post-Effective Amendment No. 90).
(17) Opinion of Venable LLP regarding legality of Class IS shares of Legg
Mason ClearBridge Appreciation Fund (formerly known as Legg Mason Partners Appreciation Fund), Class FI and Class R Shares of Legg Mason ClearBridge Equity Income Builder Fund (formerly known as Legg Mason ClearBridge Capital and Income Fund), Class
FI, Class R and Class IS shares of Legg Mason ClearBridge Capital Fund (formerly known as Legg Mason Partners Capital Fund), Class FI and Class R shares of Legg Mason ClearBridge Equity Fund (formerly known as Legg Mason Partners Equity Fund), Class
FI, Class R and Class IS shares of Legg Mason ClearBridge Large Cap Value Fund (formerly known as Legg Mason Partners Investors Value Fund), Class IS shares of Legg Mason ClearBridge Small Cap Growth Fund (formerly Legg Mason Partners Small Cap
Growth Fund) and Class FI and Class R shares of Legg Mason Investment Counsel Social Awareness Fund (formerly known as Legg Mason Partners Social Awareness Fund) is incorporated by reference to Post-Effective Amendment No. 90.
- 17 -
(18) Opinion of Willkie Farr & Gallagher LLP regarding legality of Class IS Shares
of Legg Mason ClearBridge Aggressive Growth Fund (formerly Legg Mason Partners Aggressive Growth Fund), Legg Mason ClearBridge Fundamental All Cap Value Fund (formerly Legg Mason Partners Fundamental Value Fund), Legg Mason Global Currents
International All Cap Opportunity Fund (formerly Legg Mason Partners International All Cap Opportunity Fund), Legg Mason ClearBridge Large Cap Growth Fund (formerly Legg Mason Partners Large Cap Growth Fund) and Legg Mason ClearBridge Mid Cap Core
Fund (formerly Legg Mason Partners Mid Cap Core Fund) is incorporated herein by reference to Post-Effective Amendment No. 103 as filed with the SEC on May 5, 2008 (Post-Effective Amendment No. 103).
(19) Opinion of Venable LLP regarding legality of Class IS Shares of Legg Mason ClearBridge Aggressive Growth Fund (formerly Legg Mason
Partners Aggressive Growth Fund), Legg Mason ClearBridge Fundamental All Cap Value Fund (formerly Legg Mason Partners Fundamental Value Fund), Legg Mason Global Currents International All Cap Opportunity Fund (formerly Legg Mason Partners
International All Cap Opportunity Fund), Legg Mason ClearBridge Large Cap Growth Fund (formerly Legg Mason Partners Large Cap Growth Fund) and Legg Mason ClearBridge Mid Cap Core Fund (formerly Legg Mason Partners Mid Cap Core Fund) is incorporated
herein by reference to Post-Effective Amendment No. 103.
(20) Opinion of Willkie Farr & Gallagher LLP regarding
legality of Class FI and R shares of Legg Mason Investment Counsel Financial Services Fund (formerly Legg Mason Partners Financial Services Fund) is incorporated by reference to Post-Effective Amendment No. 104 as filed with the SEC on
May 7, 2008 (Post-Effective Amendment No. 104).
(21) Opinion of Venable LLP regarding legality of Class
FI and R shares of Legg Mason Investment Counsel Financial Services Fund (formerly Legg Mason Partners Financial Services Fund) is incorporated by reference to Post-Effective Amendment No. 104.
(22) Opinion of Willkie Farr & Gallagher LLP regarding legality of Class FI and Class R shares of Legg Mason Capital Management
All Cap Fund (formerly Legg Mason Partners All Cap Fund) is incorporated herein by reference to Post-Effective Amendment No. 108 as filed with the SEC on May 30, 2008 (Post-Effective Amendment No. 108).
(23) Opinion of Venable LLP regarding legality of Class FI and Class R shares Legg Mason Capital Management All Cap Fund (formerly Legg
Mason Partners All Cap Fund) is incorporated herein by reference to Post-Effective Amendment No. 108.
(24) Opinion of
Willkie Farr & Gallagher LLP regarding legality of Class A, C, FI, R, I and IS shares of Legg Mason Target Retirement 2015 (formerly Legg Mason Partners Target Retirement 2015), Legg Mason Target Retirement 2020 (formerly Legg Mason
Partners Target Retirement 2020), Legg Mason Target Retirement 2025 (formerly Legg Mason Partners Target Retirement 2025) , Legg Mason Target Retirement 2030 (formerly Legg Mason Partners Target Retirement 2030) , Legg Mason Target Retirement 2035
(formerly Legg Mason Partners Target Retirement 2035) , Legg Mason Target Retirement 2040 (formerly Legg Mason Partners Target Retirement 2040) , Legg Mason Target Retirement 2045 (formerly Legg Mason Partners Target Retirement 2045) , Legg Mason
Target Retirement 2050 (formerly Legg Mason Partners Target Retirement 2050) and Legg Mason Target Retirement Fund (formerly Legg Mason Partners Target Retirement Fund) is incorporated by reference to Post-Effective Amendment No. 110.
(25) Opinion of Venable LLP regarding legality of Class A, C, FI, R, I and IS shares of Legg Mason Target Retirement 2015
(formerly Legg Mason Partners Target Retirement 2015), Legg Mason Target Retirement 2020 (formerly Legg Mason Partners Target Retirement 2020), Legg Mason Target Retirement 2025 (formerly Legg Mason Partners Target Retirement 2025) , Legg Mason
Target Retirement 2030(formerly Legg Mason Partners Target Retirement 2030) , Legg Mason Target Retirement 2035 (formerly Legg Mason Partners Target Retirement 2035) , Legg Mason Target Retirement 2040 (formerly Legg Mason Partners Target Retirement
2040) , Legg Mason Target Retirement 2045 (formerly Legg Mason Partners Target Retirement 2045) , Legg Mason Target Retirement 2050 (formerly Legg Mason Partners Target Retirement 2050) and Legg Mason Target Retirement Fund (formerly Legg Mason
Partners Target Retirement Fund) is incorporated by reference to Post-Effective Amendment No. 110.
- 18 -
(26) Opinion of Willkie Farr & Gallagher LLP regarding the legality of Class R1
shares of Legg Mason ClearBridge Appreciation Fund (formerly Legg Mason Partners Appreciation Fund), Legg Mason ClearBridge Large Cap Value Fund (formerly Legg Mason ClearBridge Investors Value Fund), Legg Mason Batterymarch Global Equity Fund
(formerly Legg Mason Partners Global Equity Fund) and Legg Mason ClearBridge Small Cap Growth Fund (Legg Mason Partners Small Cap Growth Fund) is incorporated by reference to Post-Effective Amendment No. 137.
(27) Opinion of Venable LLP regarding the legality of Class R1 shares of Legg Mason ClearBridge Appreciation Fund (formerly Legg Mason
Partners Appreciation Fund), Legg Mason ClearBridge Large Cap Value Fund (formerly Legg Mason ClearBridge Investors Value Fund), Legg Mason Batterymarch Global Equity Fund (formerly Legg Mason Partners Global Equity Fund) and Legg Mason ClearBridge
Small Cap Growth Fund (Legg Mason Partners Small Cap Growth Fund) is incorporated by reference to Post-Effective Amendment No. 137.
(28) Opinion of Willkie Farr & Gallagher LLP regarding the legality of Class R1 shares of Legg Mason Target Retirement 2015 (formerly Legg Mason Partners Target Retirement 2015), Legg Mason
Target Retirement 2020 (formerly Legg Mason Partners Target Retirement 2020), Legg Mason Target Retirement 2025 (formerly Legg Mason Partners Target Retirement 2025) , Legg Mason Target Retirement 2030(formerly Legg Mason Partners Target Retirement
2030) , Legg Mason Target Retirement 2035 (formerly Legg Mason Partners Target Retirement 2035) , Legg Mason Target Retirement 2040 (formerly Legg Mason Partners Target Retirement 2040) , Legg Mason Target Retirement 2045 (formerly Legg Mason
Partners Target Retirement 2045) , Legg Mason Target Retirement 2050 (formerly Legg Mason Partners Target Retirement 2050) and Legg Mason Target Retirement Fund (formerly Legg Mason Partners Target Retirement Fund) is incorporated by reference to
Post-Effective Amendment No. 140 as filed with the SEC on April 1, 2009 (Post-Effective Amendment No. 140).
(29) Opinion of Venable LLP regarding the legality of Class R1 shares of Legg Mason Target Retirement 2015 (formerly Legg Mason Partners Target Retirement 2015), Legg Mason Target Retirement 2020
(formerly Legg Mason Partners Target Retirement 2020), Legg Mason Target Retirement 2025 (formerly Legg Mason Partners Target Retirement 2025) , Legg Mason Target Retirement 2030(formerly Legg Mason Partners Target Retirement 2030) , Legg Mason
Target Retirement 2035 (formerly Legg Mason Partners Target Retirement 2035) , Legg Mason Target Retirement 2040 (formerly Legg Mason Partners Target Retirement 2040) , Legg Mason Target Retirement 2045 (formerly Legg Mason Partners Target
Retirement 2045) , Legg Mason Target Retirement 2050 (formerly Legg Mason Partners Target Retirement 2050) and Legg Mason Target Retirement Fund (formerly Legg Mason Partners Target Retirement Fund) is incorporated by reference to Post-Effective
Amendment No. 140.
(30) Opinion of Willkie Farr & Gallagher LLP regarding legality of Class A, Class C,
Class I, Class FI, Class R and Class IS shares of Legg Mason Permal Tactical Allocation Fund is incorporated herein by reference to Post-Effective Amendment No. 141.
(31) Opinion of Venable LLP regarding legality of Class A, Class C, Class I, Class FI, Class R and Class IS shares of Legg Mason Permal Tactical Allocation Fund is incorporated herein by reference to
Post-Effective Amendment No. 141.
(32) Opinion of Willkie Farr & Gallagher LLP regarding the legality of Class
R1 shares of Legg Mason Capital Management All Cap Fund (formerly Legg Mason Partners All Cap Fund) is incorporated herein by reference to Post-Effective Amendment No. 146.
(33) Opinion of Venable LLP regarding the legality of Class R1 shares of Legg Mason Capital Management All Cap Fund (formerly Legg Mason
Partners All Cap Fund) is incorporated herein by reference to Post-Effective Amendment No. 146.
(34) Opinion of Willkie
Farr & Gallagher LLP regarding legality of Class R1 Shares of Legg Mason ClearBridge Aggressive Growth Fund is incorporated herein by reference to Post-Effective Amendment No. 149 as filed with the SEC on October 30, 2009
(Post-Effective Amendment No. 149).
(35) Opinion of Venable LLP regarding legality of Class R1 Shares of Legg
Mason ClearBridge Aggressive Growth Fund is incorporated herein by reference to Post-Effective Amendment No. 149.
- 19 -
(36) Opinion of Willkie Farr & Gallagher LLP regarding the legality of Class R1
shares of Legg Mason ClearBridge Fundamental Value Fund and Legg Mason ClearBridge Small Cap Value Fund is incorporated herein by reference to Post-Effective Amendment No. 150.
(37) Opinion of Venable LLP regarding the legality of Class R1 shares of Legg Mason ClearBridge Fundamental Value Fund and Legg Mason
ClearBridge Small Cap Value Fund is incorporated herein by reference to Post-effective Amendment No. 150.
(38) Opinion of
Willkie Farr & Gallagher LLP regarding the legality of Class R1 shares of Legg Mason ClearBridge Capital Fund, Legg Mason ClearBridge Tactical Dividend Income Fund (formerly known as Legg Mason ClearBridge Diversified Large Cap Growth
Fund), Legg Mason ClearBridge Dividend Strategy Fund, Legg Mason Esemplia Emerging Markets Equity Fund, Legg Mason ClearBridge Equity Fund, Legg Mason Global Currents International All Cap Opportunity Fund and Legg Mason ClearBridge Mid Cap Core
Fund is incorporated by reference to Post-Effective Amendment No. 153 as filed with the SEC on November 24, 2009 (Post-Effective Amendment No. 153).
(39) Opinion of Venable LLP regarding the legality of Class R1 shares of Legg Mason ClearBridge Capital Fund, Legg Mason ClearBridge Tactical Dividend Income Fund (formerly known as Legg Mason ClearBridge
Diversified Large Cap Growth Fund), Legg Mason ClearBridge Dividend Strategy Fund, Legg Mason Esemplia Emerging Markets Equity Fund, Legg Mason ClearBridge Equity Fund, Legg Mason Global Currents International All Cap Opportunity Fund and Legg Mason
ClearBridge Mid Cap Core Fund is incorporated by reference to Post-Effective Amendment No. 153.
(40) Opinion of Willkie
Farr & Gallagher LLP regarding the legality of Class R1 shares of Legg Mason ClearBridge Large Cap Growth Fund and Legg Mason Batterymarch U.S. Large Cap Equity Fund is incorporated herein by reference to Post-Effective Amendment
No. 155 as filed with the SEC on January 6, 2010 (Post-Effective Amendment No. 155).
(41) Opinion
of Venable LLP regarding the legality of Class R1 shares of Legg Mason ClearBridge Large Cap Growth Fund and Legg Mason Batterymarch U.S. Large Cap Equity Fund is incorporated herein by reference to Post-Effective Amendment No. 155.
(42) Opinion of Willkie Farr & Gallagher LLP regarding legality of Class IS shares and Class R1 shares of Legg Mason ClearBridge
Equity Income Builder Fund is incorporated herein by reference to Post-Effective Amendment No. 159.
(43) Opinion of
Venable LLP regarding legality of Class IS shares and Class R1 shares of Legg Mason ClearBridge Equity Income Builder Fund is incorporated herein by reference to Post-Effective Amendment No. 159.
(44) Opinion of Willkie Farr & Gallagher LLP regarding legality of Class R1 shares of Legg Mason Investment Counsel Social
Awareness Fund, Legg Mason Lifestyle Allocation 100%, Legg Mason Lifestyle Allocation 85%, Legg Mason Lifestyle Allocation 70%, Legg Mason Lifestyle Allocation 50%, Legg Mason Lifestyle Allocation 30% and Legg Mason Lifestyle Income Fund is
incorporated by reference to Post-Effective Amendment No. 162.
(45) Opinion of Venable LLP regarding legality of Class R1
shares of Legg Mason Investment Counsel Social Awareness Fund, Legg Mason Lifestyle Allocation 100%, Legg Mason Lifestyle Allocation 85%, Legg Mason Lifestyle Allocation 70%, Legg Mason Lifestyle Allocation 50%, Legg Mason Lifestyle Allocation 30%
and Legg Mason Lifestyle Income Fund is incorporated by reference to Post-Effective Amendment No. 162.
(46) Opinion of
Venable LLP regarding legality of Class R1 shares of Legg Mason Investment Counsel Financial Services Fund (formerly Legg Mason Barrett Financial Services Fund) is incorporated by reference to Post-Effective Amendment No. 170 as filed with the
SEC on May 27, 2010.
(47) Opinion of Venable LLP regarding the legality of Class A, Class C, Class FI, Class R,
Class R1, Class I and Class IS shares of Legg Mason ClearBridge Mid Cap Growth Fund is incorporated herein by reference to Post-Effective Amendment No. 171.
(48) Opinion of Venable LLP regarding the legality of shares of Class A, Class C, Class FI, Class R, Class R1, Class I and Class IS shares of Legg Mason Global Currents International Small Cap
Opportunity Fund is incorporated herein by reference to Post-Effective Amendment No. 172.
- 20 -
(49) Opinion of Venable LLP regarding the legality of shares of Class A, Class C, Class
FI, Class R, Class I and Class IS shares of Legg Mason Dynamic Multi-Strategy Fund is incorporated herein by reference to Post-Effective Amendment No. 230.
(50) Opinion of Venable LLP regarding the legality of shares of Class A, Class C, Class FI, Class R, Class I and Class IS shares of Legg Mason ClearBridge Select Fund is incorporated herein by
reference to Post-Effective Amendment No. 246.
(51) Opinion of Venable LLP regarding the legality of shares of
Class A, Class C, Class FI, Class R, Class I and Class IS shares of Legg Mason Batterymarch Managed Volatility International Dividend Fund and Legg Mason Batterymarch Managed Volatility Global Dividend Fund is filed herewith.
(j) (1) Not applicable.
(2) Power of Attorney, dated November 3, 2011, is incorporated herein by reference to Post-Effective Amendment No. 215.
(3) Power of Attorney, dated January 31, 2012 is incorporated herein by reference to Post-Effective Amendment No. 220 as filed with the SEC on February 22, 2012.
(k) Not Applicable.
(l) Purchase Agreement between the Registrant and Shearson Lehman Brothers Inc. is incorporated herein by reference to Pre-Effective Amendment No. 1.
(m) (1) Amended Shareholder Services and Distribution Plan relating to Class A, B, C, FI, R and I Shares is incorporated herein
by reference to Post-Effective Amendment No. 74.
(2) Amended Shareholder Services and Distribution Plan relating to
Class A, B, C, FI, R and I Shares is incorporated herein by reference to Post-Effective Amendment No. 81 as filed with the SEC on January 29, 2008.
(3) Amended Shareholder Services and Distribution Plan relating to Class A, B, C, FI, R, I and IS Shares dated as of February 7, 2008 is incorporated herein by reference to Post-Effective
Amendment No. 86 as filed with the SEC on February 15, 2008.
(4) Amended Shareholder Services and Distribution Plan
relating to Class A, B, C, FI, R, I and IS Shares dated as of August 7, 2008 is incorporated herein by reference to Post-Effective Amendment No. 119 as filed with the SEC on August 28, 2008 (Post-Effective Amendment
No. 119).
(5) Amended Shareholder Services and Distribution Plan relating to Class R1 Shares dated as of
February 26, 2009 is incorporated herein by reference to Post-Effective Amendment No. 137.
(6) Amended Shareholder
Services and Distribution Plan relating to Class R1 Shares dated as of February 26, 2009 is incorporated herein by reference to Post-Effective Amendment No. 146.
(7) Amended Shareholder Services and Distribution Plan dated as of December 7, 2009 is incorporated herein by reference to Post-Effective Amendment No. 159.
(8) Amended Shareholder Services and Distribution Plan dated as of February 4, 2010 is incorporated herein by reference to
Post-Effective Amendment No. 162.
(9) Amended Shareholder Services and Distribution Plan dated as of August 5, 2010
is incorporated herein by reference to Post-Effective Amendment No. 177.
(n)(1) Rule 18f-3(d) Multiple
Class Plan of the Registrant pursuant to Rule 18f-3 is incorporated herein by reference to Post-Effective Amendment No. 76.
(o) Not Applicable.
(p)(1) Code of Ethics of Legg Mason & Co., LLC
(adopted by LMPFA, LMIS and LMGAA) is incorporated herein by reference to Post-Effective Amendment No. 215.
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(2)
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Code of Ethics of LMIE is incorporated herein by reference to Post-Effective Amendment No. 61.
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(3)
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Code of Ethics of Batterymarch dated February 1, 2005 is incorporated herein by reference to Post-Effective Amendment No. 61.
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- 21 -
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(4)
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Code of Ethics of LMIC is incorporated herein by reference to Post-Effective Amendment No. 62 as filed with the SEC on January 10, 2007 (Post-Effective
Amendment No. 62).
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(5)
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Code of Ethics of LMCM is incorporated herein by reference to Post-Effective Amendment No. 73.
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(6)
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Code of Ethics of GCIM is incorporated herein by reference to Post-Effective Amendment No. 111 as filed with the SEC on July 3, 2008.
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(7)
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Code of Ethics of Permal is incorporated herein by reference to Post-Effective Amendment No. 141.
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(8)
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Code of Ethics of ClearBridge is incorporated herein by reference to Post-Effective Amendment No. 148 as filed with the SEC on August 26, 2009.
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(9)
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Code of Ethics of WAM is incorporated herein by reference to Post-Effective Amendment No. 215.
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Item 29.
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Persons Controlled by or under Common Control with Registrant
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Not Applicable.
The response to this
item is incorporated herein by reference to Pre-Effective Amendment No. 1.
The directors and officers of the Registrant and the
personnel of the Registrants manager are insured under an errors and omissions liability insurance policy. The Registrant and its officers are also insured under the fidelity bond required by Rule 17g-1 under the Investment Company Act of
1940.
Reference is hereby made to (a) paragraph 9 of the Distribution Agreement between the Registrant and LMIS, incorporated by
reference herein.
Item 31.
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Business and Other Connections of Investment Adviser
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Investment AdviserLegg Mason Partners Fund Advisor, LLC (LMPFA)
LMPFA was formed in 2006 under the laws of the State of Delaware as a limited liability company. LMPFA is a direct wholly-owned subsidiary of Legg Mason,
Inc. (Legg Mason).
LMPFA is registered as an investment adviser under the Investment Advisers Act of 1940, as amended (the
Advisers Act). The list required by this Item 31 of officers and directors of LMPFA together with information as to any other business, profession, vocation or employment of a substantial nature engaged in by such officers and
directors during the past two years, is incorporated by reference to Schedules A and D of Form ADV filed by LMPFA pursuant to the Advisers Act (SEC File No. 801-66785).
Investment AdviserLegg Mason Capital Management, LLC. (LMCM)
LMCM
is organized under the laws of the State of Maryland as a limited liability company. LMCM is a direct wholly-owned subsidiary of Legg Mason.
LMCM is registered as an investment adviser under the Advisers Act. The list required by this Item 31 of officers and directors of LMCM together
with information as to any other business, profession, vocation or employment of a substantial nature engaged in by such officers and directors during the past two years, is incorporated by reference to Schedules A and D of Form ADV filed by LMCM
pursuant to the Advisers Act (SEC File No. 801-18115).
SubadviserClearBridge Advisors, LLC (formerly known
as CAM North America, LLC) (ClearBridge)
ClearBridge was organized under the laws of the State of Delaware as a limited
liability company. ClearBridge is a direct wholly-owned subsidiary of Legg Mason.
ClearBridge is registered as an investment adviser under
the Advisers Act. The list required by this Item 31 of officers and directors of ClearBridge together with information as to any other business, profession, vocation or
- 22 -
employment of a substantial nature engaged in by such officers and directors during the past two years, is incorporated by reference to Schedules A and D of Form ADV filed by ClearBridge pursuant
to the Advisers Act (SEC File No. 801-64710).
SubadviserBatterymarch Financial Management, Inc.
(Batterymarch)
Batterymarch was organized under the laws of the State of Maryland as a corporation. Batterymarch is an
indirect wholly-owned subsidiary of Legg Mason.
Batterymarch is registered as an investment adviser under the Advisers Act. The list required
by this Item 31 of officers and directors of Batterymarch together with information as to any other business, profession, vocation or employment of a substantial nature engaged in by such officers and directors during the past two years, is
incorporated by reference to Schedules A and D of Form ADV filed by Batterymarch pursuant to the Advisers Act (SEC File No. 801 - 48035).
SubadviserGlobal Currents Investment Management, LLC (GCIM)
GCIM
was organized under the laws of the State of Delaware as a limited liability corporation. GCIM is a wholly owned subsidiary of Legg Mason.
GCIM is registered as an investment adviser under the Advisers Act. The list required by this Item 31 of officers and directors of GCIM together
with information as to any other business, profession, vocation or employment of a substantial nature engaged in by such officers and directors during the past two years, is incorporated by reference to Schedules A and D of Form ADV filed by GCIM
pursuant to the Advisers Act (SEC File No. 801-68663).
SubadviserLegg Mason International Equities Limited
(LMIE)
The list required by this Item 31 of officers and directors of LMIE, together with information as to any other
business, profession, vocation or employment of a substantial nature engaged in by such officers and directors during the past two years, is incorporated by reference to Schedules A and D of Form ADV filed by LMIE pursuant to the Advisers Act (SEC
File No. 801-57655).
SubadviserLegg Mason Global Asset Allocation, LLC (LMGAA).
LMGAA is organized under the laws of the State of Delaware as a limited liability company. LMGAA is a wholly-owned subsidiary of Legg
Mason.
LMGAA is registered as an investment adviser under the Advisers Act. The list required by this Item 31 of officers and directors
of LMGAA together with information as to any other business, profession, vocation or employment of a substantial nature engaged in by such officers and directors during the past two years, is incorporated by reference to Schedules A and D of Form
ADV filed by LMGAA pursuant to the Advisers Act (SEC File No. 801-67287).
SubadviserLegg Mason Investment
Counsel, LLC (LMIC)
LMIC is organized under the laws of the State of Maryland as a limited liability company. LMIC is a
wholly-owned subsidiary of Legg Mason.
LMIC is registered as an investment adviser under the Advisers Act. The list required by this
Item 31 of officers and directors of LMIC together with information as to any other business, profession, vocation or employment of a substantial nature engaged in by such officers and directors during the past two years, is incorporated by
reference to Schedules A and D of Form ADV filed by LMIC pursuant to the Advisers Act (SEC File No. 801-63656).
SubadviserPermal Asset Management Inc. (Permal)
Permal was formed in June 2002 under the laws of the State of Delaware as a corporation. Permal is a wholly-owned subsidiary of Legg Mason. Permal is registered as an investment adviser under the Advisers
Act. The list required by this Item 31 of officers and directors of Permal, together with information as to any other business, profession, vocation or employment of a substantial nature engaged in by such officers and directors during the past
two years, is incorporated by reference to Schedules A and D of Form ADV filed by Permal pursuant to the Advisers Act (SEC File No. 801-61864).
- 23 -
SubadviserWestern Asset Management Company (WAM)
WAM is an investment adviser registered with the SEC under the Advisers Act. The following is a list of the officers and directors of WAM.
Directors
Ronald R. Dewhurst
James W. Hirschmann III
Jeffrey A.
Nattans
Officers
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Bruce D. Alberts
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Chief Financial Officer
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Brett B. Canon
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Director of Risk Management and Operations
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Daniel E. Giddings
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Assistant Secretary
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James W. Hirschmann III
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Chief Executive Officer and President
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James J. Flick
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Director of Global Client Service and Marketing
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Dennis J. McNamara
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Director of Portfolio Operations
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Charles A. Ruys de Perez
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Secretary, General Counsel and Head of Legal and Compliance
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Following is a list of other substantial business activities in which directors, officers or partners of WAM have been
engaged as director, officer, employee, partner or trustee.
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Officer/Director
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Other Offices Held
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Jeffrey A. Nattans
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Director, WAM
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Vice President, Legg Mason, Inc.
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Manager and Vice President, LMIH
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Director, WAML
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Director, Western Japan
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Director, WAM Australia
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Director, WAMCO Hldgs Ltd.
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Director, Western Singapore
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Officer/Director
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Other Offices Held
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James W. Hirschmann III
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Director, WAM
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Director, WAML
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Item 32.
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Principal Underwriter
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(a) LMIS, the
distributor of the Registrant, is a distributor of funds that are series of the following registrants: Legg Mason Partners Premium Money Market Trust, Legg Mason Partners Institutional Trust, Legg Mason Partners Money Market Trust, Legg Mason
Partners Variable Equity Trust, Legg Mason Partners Variable Income Trust, Legg Mason Partners Income Trust, Legg Mason Charles Street Trust, Inc., Legg Mason Global Trust, Inc., Legg Mason Capital Management Growth Trust, Inc., Legg Mason
Investment Trust, Inc., Legg Mason Capital Management Special Investment Trust, Inc., Legg Mason Tax-Free Income Fund, Legg Mason Capital Management Value Trust, Inc., Western Asset Funds, Inc. and Legg Mason Global Asset Management Trust.
LMIS is the placement agent for funds that are series of Master Portfolio Trust.
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(b) The information required by this Item 32 with respect to each director and officer of LMIS is
listed below:
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|
|
|
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Name and Principal
Business Address*
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Position and Offices
with Underwriter LMIS
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Positions and Offices with
Registrant
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Thomas J. Hirschmann
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Co-Managing Director
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None
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|
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Joseph A. Sullivan
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Co-Managing Director
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None
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Jeremy OShea
100 First Stamford Pl.
Stamford, CT 06902-6732
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Vice President
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None
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Matthew Schiffman
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Vice President
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None
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100 First Stamford Pl.
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|
|
|
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Stamford, CT 06902-6732
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|
|
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Jason Bennett
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Chief Financial Officer, Treasurer
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None
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|
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and Financial Reporting Officer
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|
|
|
|
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Kenneth D. Cieprisz
|
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Chief Compliance Officer
|
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None
|
620 8th Avenue, 49th Floor
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|
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New York, NY 10018
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|
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Elisabeth F. Craig
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|
Secretary
|
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None
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|
|
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Vicki Schmelzer
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|
Assistant Secretary
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None
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|
|
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Susan Kerr
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AML Compliance Officer
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None
|
100 First Stamford Pl.
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|
|
|
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Stamford, CT 06902
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|
|
|
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*
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All addresses are 100 International Drive, Baltimore, Maryland 21202, unless otherwise indicated.
|
(c) Not applicable.
Item 33.
|
Location of Accounts and Records
|
With
respect to the Registrant:
(1) Legg Mason Partners Equity Trust
55 Water Street
New York, New York 10041
With respect to the Registrants Investment Managers:
(2) Legg Mason Partners Fund Advisor, LLC
620 Eighth Avenue
New York, NY 10018
(3) Legg
Mason Capital Management, LLC
100 International Drive
Baltimore, MD 21202
With
respect to the Registrants Subadvisers:
(4) Legg Mason International Equities Limited
620 Eighth Avenue
New York, NY 10018
(5) Batterymarch Financial Management, Inc.
John Hancock Tower
200 Clarendon Street
Boston, MA 02116
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(6) ClearBridge Advisors, LLC
620 Eighth Avenue
New York, NY 10018
(7) Legg Mason Global Asset Allocation, LLC
100 First Stamford Place
Stamford, CT 06902
620 Eighth Avenue
New York, NY 10018
(8) Legg Mason Investment Counsel, LLC
100 International Drive
Baltimore, MD 21202
(9) Global Currents Investment Management, LLC
100 International Drive
Baltimore, MD 21202
(10) Permal Asset Management Inc.
900 Third Avenue
New York, NY 10022
(11) c/o
Western Asset Management Company
620 Eighth Avenue
New York, New York 10018
With respect to the Registrants Custodian:
(12) State Street Bank and Trust Company
One Lincoln Street
Boston, MA 02111
With respect to the Registrants Transfer Agent:
(13) Boston Financial Data Services, Inc.
2000 Crown Colony Drive
Quincy, Massachusetts 02169
(14) BNY Mellon Investment Servicing (US) Inc.
4400 Computer Drive
Westborough, MA 01581
With respect to the Registrants Distributor:
(15) Legg Mason Investor Services, LLC
100 International Drive
Baltimore, MD 21202
Item 34.
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Management Services
|
Not applicable.
Not applicable.
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