At a meeting on Thursday of the SEC’s Investor Advisory Committee, a subcommittee reported on its recommendations addressing the “proxy plumbing” conundrum—not the Roto Rooter variety, but rather the panoply of problems associated with the infrastructure supporting the proxy voting system. Shareholder voting is viewed as fundamental to keeping boards and managements accountable, and according to the recommendations, every year, over 600 billion shares are voted at more than 13,000 shareholder meetings. However, there is broad agreement that the current system of proxy plumbing is inefficient, opaque and, all too often, inaccurate. As the recommendations observe, under the current system, shareholders “cannot determine if their votes were cast as they intended; issuers cannot rapidly determine the outcome of close votes; and the legitimacy of corporate elections, which depend on accurate, reliable, and transparent vote counts, is routinely called into doubt.” In 2010, the SEC issued a concept release soliciting public comment on whether the SEC should propose revisions to its proxy rules to address these issues, but to no avail. (See this Cooley News Brief.) However, in the last year or so, proxy plumbing has reemerged as a serious problem to be addressed. The Committee took up this issue almost a year ago and, at the SEC’s proxy process roundtable last year, proxy voting mechanics was actually a hot topic—described by one panelist as “the most boring, least partisan and, honestly, the most important” of the roundtable topics.
Rumor has it that the SEC takes recommendations of the Committee seriously. With regard to these recommendations on proxy plumbing, the Committee decided to study them further and take a vote within a few weeks. As a result, there could be changes to the recommendations below.
In his opening statement at the meeting, SEC Chair Jay Clayton wondered why “Main Street investors with direct holdings are voting less often, and [whether there are] aspects of our proxy system that discourage Main Street investor participation? Are they overloaded? Are they indifferent on some, many or virtually all of the matters submitted to shareholders? If so, why are they indifferent? Is the process too cumbersome and, if so, can it be made less so? Are the matters submitted for a vote important to long term shareholder value? Who should decide whether they are or could be?…For investors that invest in companies indirectly through mutual funds or ETFs, are these funds’ fiduciaries satisfying their duty of care and loyalty with respect to services undertaken on the fund’s behalf, including voting? Can our proxy system be improved so that it is easier to do so?”
In this statement last year, SEC Commissioner Robert Jackson characterized as “urgent” the need “to fix the basic mechanics of modern corporate democracy.” He indicated that “there is broad agreement that the Byzantine system that makes it impossible to know whether investors’ votes are being counted must be fixed. Over the last decade, while voting technology has made enormous leaps forward, retail investor participation in corporate elections has declined: today, fewer than one in three investors have their vote counted in those contests. The Commission has known this for years—we issued an impressively thorough concept release on the subject in 2010—and it is time to act. Investors should not have to wait any longer for their votes to be counted in corporate elections.”
While the issues comprehended by the concept of “proxy plumbing” are described at length in this PubCo post and this PubCo post, it’s worthwhile for this purpose to summarize them briefly here:
Archaic infrastructure. Observers have described the current system of share ownership and intermediaries as a byzantine one that accreted over time—certainly not the system anyone would create if starting from scratch. There has been broad agreement that the current system of proxy plumbing is inefficient and opaque and that the current voting structure is sorely outdated and overly complex, which can make it difficult to arrive at an accurate vote tabulation. Some have suggested that the answer may lie in technology. Should pilots be commenced using new technologies, such as “private and permissioned blockchain” (with or without a gatekeeper)? Could that reduce complexity and improve traceability? Or is it just another shiny new object? The recommendations indicate that “the basic technologies necessary for tracking shares and votes—essentially a spreadsheet plus electronic communication—have been available for decades,” but “incentives and private interests (as affected by existing regulation), coupled with the externalities of networks,” have prevented implementation of “a single, reformed technological platform.”
Inaccuracies in vote count. To say that there doesn’t seem to be a lot of confidence in the accuracy of the vote count would be an understatement. The Securities Transfer Association found that, out of 183 meetings its members had tabulated in that past year, 130 had overvoting problems. Although most were ultimately reconciled, the question remained as to why the overvoting occurred. There are many issues related to the inaccuracy of vote counts—overvoting, undervoting, empty voting (when voting rights and economic interest are separated), breaks in the chain of custody, improperly completed proxy cards and difficulties associated with vote counting, confirmation and reconciliation. These issues arise out of the decision made decades ago to move to a system of share immobilization, under which most shares are held in street name and reflected in positions listed at a centralized depositary (DTC), where they are treated as a “fungible mass of shares not traceable to any individual.” While the system makes share transfers easier, the arrangement is itself complex, compounded by many layers of intermediation—the transfer agent, the custodian and perhaps several subcustodians—that can complicate and obscure proxy voting and lead to mismatches that ultimately disqualify votes. What’s more, not all shares are voted in accordance with the instructions of the beneficial owner. For example, custodians generally can’t vote shares that have been lent out and are not on their books on the record date, and yet the custodians may not directly receive information about the record date on a sufficiently timely basis to recall the shares in to order to vote them. Similarly, shares transferred after the record date are often not voted or voted inaccurately.
Vote confirmation. Shareholders tend to assume their shares have been voted, but that may not really be the case. As a basic matter, investors should have the ability to see through the chain of intermediaries to confirm that their shares have been voted as directed, but it’s often difficult or impossible for them to do so. This problem is exacerbated by the practice of share lending, as noted above, and there is apparently little transparency regarding share lending practices.
Shareholder communications. Communication with shareholders remains an issue, both in terms of all shareholders receiving their voting information on a timely basis, as well as the inability of companies to communicate with OBOs (objecting beneficial owners). Questions have been raised about the ongoing retention of the NOBO/OBO distinction, particularly the apparent default to OBO status for clients at many brokers (although, technically, NOBO status is supposed to be the default). Why do investors choose to be OBOs—are they confusing anonymity as an investor with anonymity as a proxy voter? If so are there other ways to address that issue? Do shareholders really understand the difference—or care? In any case, revelation of shareholders’ names and contact information, whether to companies or to activists, can be viewed as privacy issue—a big issue these days.
Universal proxy. Universal proxy is a proxy card that, when used in a contested election, includes a complete list of board candidates, thus allowing shareholders to vote for their preferred combination of dissident and management nominees using a single proxy card. In the absence of universal proxy, in contested director elections, shareholders can choose from both slates of nominees only if they attend the meeting in person. Otherwise, they are required to choose an entire slate from one side or the other. Because a later-dated proxy revokes an earlier-dated one under state law, it’s not easy to split votes between slates.
Strongly held opinions have been voiced about universal proxies, both pro and con. The historic view has been that dissidents—hedge fund activists and otherwise—tend to favor universal proxies, while companies have more often opposed them. More recently, however, a consensus has developed about the potential value of universal proxy cards in proxy contests, as some issuers have apparently recognized that universal proxy could, in some cases, help the management slate. (See this PubCo post.) In 2016, the SEC proposed amendments to the proxy rules that would have mandated the use of universal proxy cards in contested elections, but nothing came of the controversial proposal—at least not yet. (See this PubCo post.)
Even if there is now more willingness in both camps to consider universal proxy, the details will matter. For example, one issue that remains on the table is the percentage of shareholders that dissidents would need to solicit. The requirement in the SEC proposal was to solicit a majority of shares, but others maintain that, to be fair, there should be parity with the solicitation requirements applicable to companies, meaning that all shareholders should be solicited. Other issues are whether the SEC should require companies to disclose what would happen if an incumbent director refused to serve if a dissident were elected, and possible permutations in the outcomes of the director vote—for example, what if there were no director who could be the audit committee chair? What would happen if the dissident violated the rules?
Proxy advisory firms. Many have expressed the view that proxy advisory firms, such as ISS and Glass Lewis, have undue influence over the proxy process, as too many institutions outsource their voting decisions. While many of the larger institutions have taken decision-making back in house, a large number have not. The SEC seems to be considering this issue currently, and the issue is not addressed in the recommendations. (See this PubCo post and this PubCo post.)
While there is a broad agreement that something should be done, the question is: what is that something and who should do it? At the proxy process roundtable, the ultimate question was whether we should reimagine the whole system from scratch or just try to repair the existing system? A number of panelists argued that, while some system participants had taken useful steps, overall the system was “patched together” and needed a fundamental rethinking. That didn’t mean, however, that near-term steps, such as routine and reliable vote confirmation, guidance on reconciliation and universal proxy, couldn’t be undertaken now. On that issue, there was no agreement at the roundtable. The recommendations of the IAC go for the low-hanging fruit.
A preliminary question was whether the issues could be addressed through private ordering or was SEC involvement necessary? The recommendations suggest that, because few elections are close enough that voting inaccuracies matter—most of the time voting inaccuracies do not have a “direct and significant effect on the outcome under corporate law”—individual companies do not have sufficient incentive to fix the system on their own. For a single company, “the expected benefits of investments in improved voting technology or services may not exceed their costs.” But when a vote is close, for example in board elections, board control can be unsettled, with obvious consequences for the company. At that point, however, “it is too late for the company and its shareholders to make the large and long-term investments an accurate and timely system requires. Since some close votes do occur every year, companies and investors have a significant collective interest in a reliable system.” Nevertheless, in the individual case, the pressure is not high enough to move the issue up the list of priorities. In other words, private ordering to address these problems seems highly unlikely.
- “The SEC should require end-to-end vote confirmations to end-users of the proxy system, potentially commencing with a pilot involving the largest companies.” As noted above, investors are currently unable to determine if their shares were voted as they instructed. The recommendations suggest that the SEC require that confirmations be sent to each individual or institution with final voting authority over any shares indicating that the shares were voted as instructed and, if not, the reason why not. The recommendations argue that this information “would increase confidence in the proxy system and provide incentives for those involved to eliminate routine problems that prevent proxies or voting instructions from being implemented as shareholders direct. Inquiries from investors when instructions are not implemented will organically generate root-causes analyses of the reasons for that failure. Those analyses will provide the foundation for a continuous cycle of system improvements over time.” Initially, issuers would pay the costs, but costs “should shift to intermediaries who are unable or unwilling to provide investor identification to companies. Intermediaries would have an affirmative reason to persuade ‘objecting’ clients to become NOBOs.” The recommendation also indicates that “Broadridge has created a method for institutional investors to use an online end-to-end voting system, which allows for confirmations of votes. Uptake on the system has been slow, however, and it is currently not used by individuals.” Nevertheless, the viability of the Broadridge confirmation system corroborates the technological feasibility of end-to-end confirmations under the current proxy system.
- “The SEC should require all involved in the system to cooperate in reconciling vote-related information, on a regular schedule, including outside specific votes, to provide a basis for continuously uncovering and remediating flaws in the basic ‘plumbing’ of the system.” Currently, various laws require system participants to maintain accurate books and records, but these obligations vary and they may not always be enforced. The SEC should “require every participant in the proxy system to cooperate with the others to reconcile ownership and voting information on a regular basis, both during and outside the context of specific votes. This requirement would track the existing requirement applied to transfer agents, but would be extended to custodians, banks, brokers, proxy servicers and proxy advisors.”
- “The SEC should conduct studies on (a) investor views on anonymity and (b) share lending.” The goal of the first study would be to find out whether investors really want to be anonymous or whether they choose to be OBOs due to confusion or incentives of intermediaries. A related question is “whether the nominal default rule—by which broker customers are treated as NOBOs unless they object—has been ‘flipped’ without actual customer knowledge in broker contracts.” The second study would be designed to understand the extent to which share lending “contributes to errors, over-votes or under-votes, and whether the effect of share lending on voting entitlements is effectively disclosed to investors.” How are votes associated with shares on loan processed and counted? How do those counting the votes verify that there is no overvoting and undervoting of lent shares? Are shares on loan consistently recalled for votes?
- “The SEC should adopt its proposed ‘universal proxy’ rule, with the modest changes that would be needed to address objections that have been raised to that proposal.” For example, the SEC should modify the proposal to increase—from 50% to perhaps 67% or more—the percentage of shareholders that dissidents would be required to solicit to be able to use universal proxy. With regard to the argument that the proposal should mandate a “level playing field” with companies, the recommendation contends that the company’s solicitation on behalf of the incumbent is routinely paid by the company, but dissidents are reimbursed only if they win or otherwise reach a settlement with the company. If the company knows that some incumbents may refuse to serve if elected to a split slate, that should be required to be disclosed (although, the recommendation notes, there is always a risk that a director may choose not to continue on a board for any reason).