At a meeting last week of the SEC’s Investor Advisory Committee, the primary focus of the discussion was the panoply of problems associated with the infrastructure supporting the proxy voting system, so-called “proxy plumbing.” Shareholder voting is viewed as fundamental to keeping boards and managements accountable, and the current system of proxy plumbing has been criticized as inefficient, opaque and, all too often, inaccurate. 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. Perhaps the task was too daunting. However, at the end of his brief appearance at the committee meeting, SEC Chair Jay Clayton observed that it was clear that there was room for improvement in the voting system—enough room for improvement that the SEC should do something. SEC Commissioner Robert Jackson was decidedly more emphatic. In a statement posted on the SEC website on Friday, he 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.” But the question remains: will the SEC undertake the comprehensive analysis and overhaul that appears to be required or settle for grabbing only the low-hanging fruit?
(Based solely on my notes, so standard caveats apply.)
It was just like Groundhog Day: participants at the meeting raised a number of concerns with the current system of proxy plumbing, most of which had been raised in the concept release. Interestingly, one participant commented that many of the issues regarding the proxy voting system are shared concerns among companies and activists, such as the need for accuracy and transparency. Among the comments:
- Archaic infrastructure. The current voting structure is sorely outdated and overly complex, which can make it difficult to arrive at an accurate vote tabulation. Several participants (including Commissioner Kara Stein) suggested that, from a technical perspective, the use of “private and permissioned blockchain,” developed by an intermediary, should be considered. The goal would be to provide immediate and accurate end-to-end vote confirmation and to provide prompt voting results to the company. It did not escape anyone’s notice, however, the since the initiation of online “notice and access,” retail participation levels have actually declined. One participant observed that, because the best way to increase retail participation is through direct contact mailings or phone calls, issuers were constrained by their inability to communicate directly with objecting beneficial owners (OBOs). Participants also complained that Broadridge does not use electronic communications in proxy contests, although it appears that Broadridge is working on the issue. One participant urged that any new system be equally balanced so as not to favor either companies or dissidents, retail or institutional investors and cautioned the SEC to consider carefully any unintended consequences of any technology that is adopted.
- Universal proxy. Surprisingly, there seemed to be some consensus developing on the potential value of universal proxy cards, even though concerns remain that it could favor one party over the other. A 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. Commissioner Stein noted in her opening remarks her astonishment that, notwithstanding all of our technological advances, shareholders who attend meetings still have more rights than shareholders who vote by proxy. That’s because, 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. One participant observed that, although the historic view is that universal proxy cards help only the dissident shareholders in a proxy contest, that is not necessarily the case. In the example given, ISS might recommend in favor of two of dissident candidates only, but shareholders desiring to follow the ISS recommendation would, in the absence of universal proxy, be compelled to choose one full slate or the other—and that could end up being the dissident slate—or engaging in “bullet” voting for only the two directors. With regard to the currently outstanding proposal for universal proxy (see the SideBar below), one investor representative appeared to agree (concede?) that a solicitation by the dissidents of at least 75% of the shares and more than ten persons should be required to trigger a mandate for universal proxy (in contrast to the current requirement in the SEC proposal to solicit only a majority of shares), while another participant suggested that dissidents should be required to solicit all shareholders, just as the company must. One participant noted that, should universal proxy be resuscitated, the SEC should require companies to disclose what happens when an incumbent director refuses to serve if a dissident is elected. Another issue raised was the need to ensure that shareholders do not vote for too many directors, which would disqualify the proxy card unless a chance to cure is offered. However, another participant was more wary about any mandate for universal proxies, maintaining that the devil is still in the details.
- Shareholder communications. Communication with shareholders remains an issue, both in terms of all shareholders receiving their voting information at the same time, or at least on a timely basis, as well as the inability of companies to communicate with OBOs. Apparently, some shareholders, and not just those located overseas, sometimes receive their materials after the vote. Several participants advocated allowing issuers to communicate directly with OBOs. Nevertheless, revelation of the shareholders’ names and contact information, whether to companies or to activists, can be viewed as privacy issue—a hot topic these days.
- Accurate 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. First, not all shares are voted in accordance with the instructions of the beneficial owner. For example, participants noted that 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. Another explanation posited was that, even if record date information is public, information about the agenda may not yet be available, making it difficult to decide whether or not it is worthwhile to recall the lent shares. In either case, the result is a lower vote count than should have been the case. Similarly, shares transferred after the record date are often not voted or voted inaccurately. Moreover, empty voting (when voting rights and economic interest are separated) can lead to overvoting, and one participant advocated regulation (in part because shares without an economic interest tend to be voted in favor of short-term interests). Undervoting and overvoting, which reflect mismatches between the shares recorded on the books of the voting intermediary and amounts credited by the company for the account of the intermediary, continue to be problematic. In addition, breaks in the chain of custody can lead to shares not being voted as a result of mismatching. In one example given, a slight change in the name of the voting custodian led to one large shareholder’s shares not being voted—and the problem not being caught—for ten years. As another example, sometimes the information from the intermediary doesn’t match the information on the CEDE omnibus proxy. To illustrate the importance of these problems, participants discussed various issues associated with obtaining an accurate vote count in connection with a recent proxy contest involving over 2 billion votes, where the difference in the vote total come down to ¼ of 1%.
- Layering of rules and practices. One participant suggested an end-to-end review of all the rules and historic practices that have been developed applicable to all the layers of intermediaries to see what might be eliminated. That type of review might reduce some of complexity, it was urged.
- Vote confirmation. It’s often difficult or impossible for shareholders to confirm that their shares have been voted or voted properly. Shareholders tend to assume their shares have been voted, but that may not really be the case. This problem is exacerbated by the practice of share lending, as noted above. There is apparently little transparency regarding share lending practices.
- Vote reconciliation. Share counts are sometimes not reconciled until after the preliminary certified vote has been announced, which can lead to confusion. In addition, because shareholders receive multiple mailings, the system encourages the submission of multiple proxy cards, and it can be difficult to determine which is the last voted proxy card. Reconciliation can require manual intervention, which can involve qualitative judgments.
- Concentration of voting power and proxy advisory firms. One participant observed that, in light of the increasing concentration of voting power among institutions, activists can now quickly and inexpensively communicate with the holders of a majority of the shares, but companies are disadvantaged because they must communicate with all their shareholders. The participant advocated that all shareholders receive the same information, whether from activists or the company. The participant also expressed his view that proxy advisory firms, such as ISS, had undue influence over the process, as too many institutions outsourced their voting decisions. While many of the larger institutions have taken decision-making back in house, a large number have not. What’s more, the proxy advisory firms did not, in his view, provide equal access to companies and investors.