An influential whitepaper making the rounds in corporate governance circles is advocating that the Securities and Exchange Commission take a go-slow approach to reforming the fractured state of shareholder communications as it prepares for a larger overhaul of proxy rules later this year.
The paper, commissioned by the Council Of Institutional Investors, concludes that the SEC should take an “incremental” approach to increase shareowners’ and companies’ ability to communicate directly, rather than scrap the existing structure entirely. It does, however, still call for the eventual elimination of the OBO/NOBO difference—the two classes of shareholders, “objecting beneficial owners” and “non-objecting beneficial owners,” who do or do not allow companies to communicate with them directly.
The OBO/NOBO classification has been in place since the 1980s, and critics say it is now woefully outdated for modern shareholder relations. Changing it (or abolishing it entirely) is one of many items up for discussion when the SEC publishes a forthcoming concept release that will explore how to update federal proxy rules generally, although the SEC has promised the release since last year, and when it may become public is anyone’s guess. SEC spokesmen declined to give an estimate.
The authors of the whitepaper—Alan Beller, Janet Fisher, and Rebecca Tabb of the law firm Cleary Gottlieb Steen & Hamilton (Beller was previously director of the SEC’s Corporation Finance Division)—assert that the best way to improve shareholder communications would be “an incremental approach that promotes less reliance on, or eliminates altogether, the OBO/NOBO distinction and otherwise increases the potential for direct communications.”
Such an approach “could lead to meaningful improvements, without seriously affecting the interests of many of the participants in the current framework, and we believe it has a greater chance of widespread support than more radical alternatives,” the trio wrote.
Amy Borrus, deputy director of the Council of Institutional Investors, stresses that the paper, while welcome, is not official CII policy. “We see it as a starting point for the Council’s discussion of key issues to be highlighted in the upcoming SEC concept release on proxy mechanics and voting communications,” she says.
Critics of the OBO/NOBO system say it hinders communication between companies and their shareholders, since investors who adopt the OBO classification can essentially hide behind the investment banks that hold their shares. Shareholders are classified as NOBOs by default, but institutional investors—who own larger blocs of shares and are the ones companies want to court—are more likely to be OBOs.
The OBO/NOBO system “is ripe for reform. We need to have healthy discussion to see whether we can improve the proxy and communication system to better take advantage of technology.”
—Jeff Morgan,
President and CEO,
National Investor Relations Institute
Supporters, however, say the OBO/NOBO distinction protects the privacy of investors who want to keep their holdings and trading strategies confidential and to avoid unwanted solicitations. Changing the OBO/NOBO system could also affect the practice of loaning shares to short-sellers, which is a lucrative bit of income for institutional investors.
Companies currently must forward solicitation materials to OBOs through intermediaries for a fee or pay for NOBO lists also compiled by intermediaries. The Beller paper calls that process “expensive and time-consuming” and says it may deter companies from communicating with investors.
Beller and his co-authors say broader changes to corporate governance will put more pressure on voting outcomes, which therefore increases the need for an “effective and reliable framework” for company and shareowner communications. Those changes include more frequent proxy contests or battles over board seats; a ban on brokers voting uninstructed retail shares in director elections; and wider use of shareholder proposals. The SEC is also expected to adopt some form of shareholder access to the proxy statement later this year.
Morgan
All of those changes make voting “that much more critical,” says Jeff Morgan, CEO of the National Investor Relations Institute. “What goes with that is the need for companies to have an effective way to communicate with shareholders.”
The OBO/NOBO system “is ripe for reform,” Morgan says. “We need to have healthy discussion to see whether we can improve the proxy and communication system to better take advantage of technology.”
Other Ideas
NIRI is part of the Shareholder Communications Coalition, a broad industry group advocating for change to the OBO/NOBO system. Another partner in the coalition is the Business Roundtable, which has proposed eliminating OBO/NOBO entirely and letting companies mail all proxy materials directly to beneficial owners. Brokers and banks would maintain information about their beneficial owner clients, and Broadridge (the dominant player in shareholder communications services) could create a master list of information for all beneficial owners, available to companies and shareowners for a fee.
TO CHANGE OR NOT TO CHANGE?
Some key points about changing OBO/NOBO from the Council of Institutional Investors:
Recent developments increase the likelihood of more meaningful, and contested, shareowner votes and the importance
of shareowner communications. Shareowner voting and communications depend on both state and federal law.
State law focuses on record ownership (i.e., the holder, whether or not the ultimate shareowner, shown on a company’s
books), whereas federal law reflects the interests of beneficial owners (i.e., the ultimate shareowners) in voting and
receiving disclosure.
Under Securities and Exchange Commission (SEC) rules, companies mainly communicate with beneficial owners through
broker or bank intermediaries. Intermediaries are prohibited from disclosing to a company the identity of beneficial
owners who object to that disclosure (objecting beneficial owners or OBOs), and the company cannot contact OBOs
directly. The company may contact directly shareowners who do not object (non-objecting beneficial owners or NOBOs),
but SEC rules nonetheless require that proxy materials be forwarded to them by the intermediaries. The OBO/NOBO
distinction impedes company communications with beneficial owners and communications among shareowners. Some
market participants have proposed changes to this framework. The interests of the key players vary:
Companies tend to favor the elimination of the OBO/NOBO distinction. They argue that, if shareowners can participate
more directly in board elections through proxy access or other means, companies should be able to contact them directly.
They also argue that a direct communication framework would increase shareowner participation and reduce costs.
Shareowners are often said to have a privacy interest that is served by the current framework, but a 2006 survey casts
doubt on this assertion. It is also unclear which information shareowners wish to keep private and from whom. Some
may wish to keep their holdings or trading strategies confidential, while others seek to avoid unwanted solicitations.
Shareowners seek to have unimpeded ability to communicate among the shareowner community. Shareowners also
seek a level playing field with companies—to have equal access to lists of shareowners and to have their solicitation
costs reimbursed as are those of management.
Brokers and banks have several interests—maintaining the confidentiality of customer lists, preserving fee income
derived from forwarding proxy materials, and preserving stock loan revenues, which could be at risk in a direct
communications framework that allows greater transparency to customers about stock loan practices.
Broadridge Financial Solutions is essentially the sole agent for intermediaries and companies and has an interest in
preserving the fee income and cost reimbursements it receives under the current framework.
The SEC is likely to be cautious in seeking to change the current framework in significant ways, at least in the near
term. Defining the objective is critical to developing a proposal. If the goal is to increase the ability of shareowners and
companies to communicate directly, a number of incremental steps may be taken to address the OBO/NOBO distinction
and facilitate direct distribution of proxy materials, without discarding the current distribution platform. Such an approach
could lead to meaningful improvements, without seriously affecting the interests of many of the participants in the current
framework, and we believe it has a greater chance of widespread support than more radical alternatives.
A more ambitious goal to ensure more reliable voting seems difficult to achieve without a direct communications
framework with cascading executed proxies. This approach would, however, almost certainly be more contentious, since
it would implicate complex strategic, cost, logistical and other considerations of critical importance to key players. Its
practical benefits are also uncertain because they are likely to be limited to a minority of contested elections in which an
end-to-end audit of the vote is critical to a reliable outcome. We also believe that this approach requires more detailed
analysis by the various affected constituencies to obtain a clearer picture of the logistical changes, costs and potential
disruptions it could entail.
On balance, we believe that the immediate interest of shareowners and companies in better communications would
be better and more effectively served with an incremental approach that promotes less reliance on—or eliminates
altogether—the OBO/NOBO distinction and otherwise increases the potential for direct communications.
Source
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align="left">Council of Institutional Investors (February 2010).
Goodman
Amy Goodman, a partner at the law firm Gibson Dunn & Crutcher who also serves as outside counsel for the Business Roundtable, says it is “mind-boggling” to maintain the current communication system based on 1980s technology. “Technology has dramatically changed, as has the need for enhanced shareholder communication,” she says.
Another proposal by the Altman Group, dubbed “ABO” for “all beneficial owners,” would eliminate the OBO/NOBO distinction only for record dates for annual or special meetings. “There should be a clear list of who has voting rights as of the record date,” says Ken Altman, president of the Altman Group. “ABO would give companies and soliciting shareholders a way to take their case directly to the parties who hold the votes.”
The Beller paper also reviews ideas such as charging a fee to shareholders who want to keep OBO status, or abolishing the OBO/NOBO distinction and requiring shareholders to open nominee accounts to maintain confidentiality.
Altman
Altman suggests that if fees are imposed to maintain OBO status, the money should go to funding investor education about proxy voting, which is low at the best of times. “Participation by retail owners is poor and trending down rather drastically,” he says. That means some owners “are playing no role in governance,” handing more power to institutions and proxy advisory firms.
Still, others say the OBO/NOBO debate simply isn’t that important. John Endean, president of the American Business Conference, which represents small and mid-sized companies, says his members have larger priorities than OBO/NOBO. “They’re concerned about naked short selling, client-directed voting, and better, more prompt [ownership] disclosure,” he says.
Zarb
Likewise, Frank Zarb, a former SEC attorney now at the law firm Katten Muchin Rosenman, says issuers’ desire to know who their shareholders are “is an appealing and legitimate goal … but they probably have bigger fish to fry.” He says the influence of proxy advisory firms such as RiskMetrics or Glass Lewis & Co. is a top concern for his corporate clients.
The current system “isn’t ideal for anyone, but it reflects a balancing of the interests of brokers and their client information, investors’ interest in privacy, and issuers’ desire to know who their shareholders are and communicate with them,” Zarb says.
Callan
And Chuck Callan, senior vice president at Broadridge, cites prior reviews by a Proxy Voting Review Committee and a New York Stock Exchange Proxy Working Group as evidence that the current system works well. He says the issues in dispute are policy matters, not process issues. “From a processing standpoint, there are ways to communicate with investors regardless of whether they’re OBOs or NOBOs,” he says.
Even if the SEC does move ahead with reforms, they won’t happen any time soon. After seeking comment through a concept release, the Commission would have to issue proposed rules for comment and then still vote to approve any final rules. All that takes months under the best of circumstances.
Meanwhile, companies and investors still await action on a pending SEC proposal to allow shareholders to place nominations for directors in corporate proxy statements. SEC officials have said that they’ll put the controversial proposal to a vote sometime in early 2010.
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