Since the Vanguard Group Inc. launched the Vanguard 500, the first retail index fund, in 1976, index funds and other passive investment vehicles have steadily gained market share.

Unlike actively managed funds, which offer investors an opportunity to invest in a basket of securities elected by a particular fund manager, index funds typically offer investors an opportunity to invest in all the securities in a specified index (for example, the S&P 500, the Russell 2000). In its annual report on fund flows, Morningstar Inc. reported that in 2009, passively managed mutual funds represented 27% of the total market for mutual funds for U.S. stocks, up from 15% in 2000.

As a result, index funds and other passive investment vehicles typically hold a significant percentage of the shares of most U.S. public companies. Anyone who has participated in a recent proxy contest or unsolicited takeover bid can attest that index funds often play a critical, and sometimes decisive, role in contests for corporate control of U.S. public companies.

Yet managers of index funds do not, and under their constituent fund documents typically cannot, make the most important decision an active fund manager makes: whether to buy, sell or hold a particular company's securities. Rather, an index fund's holdings are reallocated periodically to reflect changes in the underlying index. This investment strategy of following the market as a whole reduces the fund's costs, allowing the passive fund to charge fees that are lower then those charged for actively managed funds.

While a passive fund manager cannot make buy and sell decisions, it is legally required to make voting decisions.

Under the Investment Advisors Act, fund managers have fiduciary duties of loyalty and care, and those duties extend to the voting of proxies. Rule 206(4)-6 under the Advisors Act requires an investment adviser to "[a]dopt and implement written policies and procedures that are reasonably designed to ensure that advisor's proxy votes are in the best interest of clients."

The Employee Retirement Income Security Act similarly provides that if an Erisa fiduciary has authority to vote proxies, that responsibility must be discharged either by the plan trustee, a fiduciary designated by the plan or an investment manager who has designated investment authority.

Is there any reason for the government to require passive fund managers to exercise discretion in voting promises? Because a passive fund manager's business model should drive him to discharge his fiduciary obligations to vote proxies as inexpensively as possible, one should not expect a passive fund manager to invest time and money to develop an informed view about a company.

In addition, while an active fund manager's voting decision is informed by the research that led that manager to buy and hold the shares, a passive fund manager does not benefit from any prior knowledge.

A number of index funds take a market-based approach in deciding whether to tender the fund's shares into a tender offer. Many will simply tender the fund's shares if the tender price exceeds the market price.

So should we continue to require passive fund managers to exercise discretion in the voting of proxies? Or, as Institutional Shareholder Services Inc. asks in contests for the election of directors, "Is change warranted?" I would answer that question with a resounding yes.

How can change be accomplished? The Securities and Exchange Commission could issue interpretive advice that would allow advisers of passively managed funds to adopt a policy that they would not vote proxies on any shares held by the fund.

This could, however, wreak havoc with the corporate mechanics at many companies. Significant corporate actions, such as mergers, typically require the affirmative vote of a majority, and in some states a higher percentage, of the outstanding shares. In addition, a large number of public corporations now require majority voting for directors.

As a result, having a large percentage of a company's shares unvoted seems likely to do more harm than good because in these cases a nonvote is the equivalent of a negative vote.

So why not allow passive fund managers to vote their proxies the same way they make their other investment decisions: by following the market.

The SEC could issue interpretive advice allowing advisers of passively managed funds to adopt a policy that all shares of a company held by the fund will vote in the same proportion that shares are voted by unaffiliated shareholders of a company. By doing so, the proxy voting by a passive fund would mirror the voting by the shares that trade in the marketplace, thereby aligning the passive fund's proxy voting more closely to its buy and sell decisions.

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Peter D. Lyons is a partner at Shearman & Sterling LLP and a member of the firm's senior management team.