And it may even help— to some extent. A number of companies received whopping bills in the last proxy season or two for proxy distribution costs—much bigger than normal.  How did that happen? As discussed on blog, these types of increases have been attributed to “the proliferation of small accounts through no-fee trading platforms.” Many retail traders now hold very small numbers of shares of a large number of stocks, some as a result of recent opportunities to buy fractions or “slices” of shares that ultimately add up to one or more whole shares. And, in a number of cases, the retail traders didn’t even buy the shares; they were “gifted” by retail brokers as rewards for opening a new account or doing some other good deed for the benefit of the broker. It can all add up to surprisingly big charges for proxy distribution costs. But now there may be a bit of relief available—the SEC has just approved an NYSE proposal to “prohibit member organizations from seeking reimbursement, in certain circumstances, from issuers for forwarding proxy and other materials to beneficial owners.” “Certain circumstances” refers to free promotional shares awarded to account holders by brokerages. Notably, the blog raises the good question of how the exclusion will be enforceable in practice. 

Under Rule 14a-13, issuers are required to furnish proxy materials to brokers and banks for distribution to beneficial owners and, upon request, to pay the “reasonable expenses for completing the sending of such material to beneficial owners.”  Rules 14b-1 and 14b-2 require brokers and banks that hold securities in street name to forward the proxy materials to beneficial owners. NYSE Rules 451 and 465 require NYSE member organizations to solicit proxies from, and deliver proxy materials to, beneficial owners on behalf of issuers, upon receipt of proxy soliciting materials and satisfactory assurance of reimbursement “for all out-of-pocket expenses, including reasonable clerical expenses,” incurred by the NYSE member organization in connection with the solicitation. Supplementary Material .90 to Rule 451 sets forth processing and other fees that may be charged according to the circumstances and number of nominee accounts, in addition to actual postage, envelope and communication expenses incurred in receiving voting returns either telephonically or electronically for a particular distribution. 

According to the NYSE, there has been “a recent practice in which retail brokers provide customers, without charge, a small number of shares with a very small dollar value as a commercial incentive (for example, upon opening a new account or referring a new customer to the broker).”  As a result, there are frequently a large number of customers that have small positions in the company, usually representing a very small percentage of the voting power.  However, Rule 451 does not distinguish between these beneficial owners of free shares and paid shares, so brokers solicit proxies from these accounts and seek reimbursement for their expenses.  Consequently, the costs to reimburse the broker for “distributing proxies to these accounts [are] disproportionate to the maximum potential vote such shares represent.” The promotional program is undertaken by the broker for its own commercial benefit without any corresponding benefit to the issuer, and the recipients of the free shares “typically will not be given any choice as to which shares they receive and are therefore not making any investment decision.”

Some of the issuers commenting in support of the NYSE proposal described the significant increases they had experienced.  For example, in one case, the company’s 2020 proxy distribution bill was 2,402% higher than its 2019 bill, representing distribution to 3,051% more shareholders than in 2019. According to the company, 80% of the shareholders that held shares through accounts at a particular retail broker held five or fewer shares. The company believed that, for most of those accounts, shares were selected by the broker, not the beneficial owners. Another company reported that, from 2019 to 2020, the number of its shareholders holding through a particular retail broker increased by more than 2,057%, and its proxy distribution bill from that broker grew 1,779% (from approximately $12,500 to approximately $234,000). The company attributed the increases directly to the retail broker and its promotional activities.

To address this issue, the NYSE proposed to adopt Rule 451A, which would prohibit the imposition of fees for a nominee account that contains only shares or units of the particular securities that the beneficial owner received at no cost. The prohibition would apply notwithstanding the applicable provisions of Rules 451 or 465 or the rules of any other exchange. If the beneficial owner’s account contained shares of the issuer that were not free, Rule 451A would not limit the broker’s right to reimbursement for distributions, nor would the proposed rule limit reimbursement to a broker that had not gifted the shares. For example, if the beneficial owner transferred the promotional free shares into an account at another broker, the other broker could still claim reimbursement under Rules 451 and 465.  Under Rules 451 and 465, the broker would continue to be “obligated to solicit votes from, and make other distributions on behalf of issuers to, all beneficial owners notwithstanding the limitations on reimbursement of expenses imposed by proposed Rule 451A.”

Brokers would continue to be reasonably reimbursed for their actual non-fee-related expenses. In “specifically stating that no ‘fee’ shall be imposed,” the NYSE said in Amendment No. 3, Rule 451A is “meant to apply to the charges that are specified in Rule 451. In addition to the charges specified in Rule 451, member organizations also are entitled to receive reimbursement for: (i) actual postage costs (including return postage at the lowest available rate); (ii) the actual cost of envelopes (provided they are not furnished by the person soliciting proxies); and (iii) any actual communication expenses (excluding overhead) incurred in receiving voting returns either telephonically or electronically.” That is, for “the avoidance of doubt, proposed Rule 451A would not limit a member organization’s eligibility to receive reimbursement for any such postage, envelope, and voting return communication expenses incurred in connection with a distribution of proxy and other materials” even when the shares in the nominee account “were derived solely from the member organization at no cost.” The NYSE believes that this approach is consistent with the application of the other fee exclusion of Rule 451 related to managed accounts that contain five or fewer shares (discussed in the SideBar above).

Accordingly, the effect of the proposal would be to reduce the overall aggregate reimbursement received by that broker for a distribution, but not to eliminate reimbursement entirely. In approving the proposal, the SEC concluded that it “would result in a more equitable and not unfairly discriminatory reallocation to brokers of significant costs typically associated with the distribution of proxies and other materials in the circumstances addressed by the proposal.”  Issuers that receive alarming bills for distribution costs in the future may want to dig a little deeper and ask the broker to provide data supporting the reimbursement requests, including how these exceptions were addressed.

Posted by Cydney Posner