Proxy Overhaul Calls for Help on Voting Accuracy

All you compliance and financial reporting executives frustrated with corporate reporting in the United States, here’s your big chance: The Securities and Exchange Commission is finally giving the federal proxy system a long-overdue review.

The SEC published a 151-page concept release last week, asking dozens of questions about what the agency should consider as it tries to bring America’s antiquated system of proxy voting into the modern age. The public now has 90 days to submit its comments.

The release focuses on three broad issues: accuracy and transparency in the proxy voting process; effective ways for shareholders and corporations to communicate; and the relationship between voting power and economic interest.

Cross

“While we believe the system overall is working, it is certainly reasonable that it can work better,” Meredith Cross, director of the SEC’s Division of Corporation Finance, said during an SEC open meeting on July 14 to discuss the release. “After we receive public input, we expect to bring recommendations to the Commission for changes to the rules if it appears the changes would help investors and improve the proxy system.”

Still, concrete rule changes stemming from the concept release might not arrive for quite a while. SEC rules take months to develop under the best of circumstances, and the concept release comes just as the SEC is receiving orders from Congress for dozens of other new rules and studies as part of the Dodd-Frank Act, which lawmakers finally enacted last week. Any rule changes related to the concept release probably won’t come to the SEC for a final vote until sometime next year, to go into effect with annual reports filed in 2012.

The actual text of the concept release was also published July 14. It is part of a broader SEC review of the infrastructure of the U.S. proxy voting system, the first review in nearly 30 years. Since that last look at the system, the release notes, the U.S. capital markets have undergone huge changes in technology, structure, shareholder demographics, and more, all making an overhaul of the system long overdue.

In particular, shareholder activists have grown concerned about the accuracy of vote totals in proxy contests. The U.S. proxy system sees more than 600 billion shares voted at roughly 13,000 annual meetings every year. Yes, most of those votes are predictable, boring affairs, but Corporate America has also seen numerous governance reforms in recent years: majority election for board directors, bars against broker-dealers voting in director elections, and more frequent proxy fights, to name a few. Those trends have made accuracy in vote outcomes much more important when proxy skirmishes do arise.

Allen

“It’s a different world from when the proxy rules were created,” says Claudia Allen, chair of the corporate governance practice in the law firm Neal Gerber Eisenberg. “The ability to have precise accurate transparent votes is increasingly important.”

Voting Details

Two issues the SEC’s concept release wants to address are the threats of “over-voting” and “under-voting”: the idea that broker-dealers or other intermediaries might be casting more or fewer votes than the number of shares they actually own. The concept release attributes this phenomenon to imbalances in how securities transactions are cleared and settled in U.S. capital markets.

‘After we receive public input, we expect to bring to recommendations to the commission for changes to the rules if it appears the changes would help investors and improve the proxy system.’

—Meredith Cross,

Director,

SEC Division of Corporation Finance

Some broker-dealers have developed methods to reconcile their records and allocate votes to their customers to avoid over-voting, but the concept release notes that one of those methods may result in under-voting. It also asks for evidence—statistical, anecdotal, or otherwise—that over-voting or under-voting have ever had a material effect on the outcome of a proxy contest. And the concept release asks whether broker-dealers should be required to disclose their allocation and reconciliation processes, whether that would even be an adequate response to the risk, and whether the SEC should require some particular allocation and reconciliation method.

Likewise, the concept release explores the risk of “empty voting,” where voting rights are decoupled from the economic interests of shareholders—say, a hedge fund borrowing some shares to vote against some useful deal for a company, and then profiting from a decline in share price since the fund is shorting the stock. (Proxy critics say empty voting exists, but nobody has ever definitively proven that it has affected the outcome of, say, a merger vote or a director election.) The release asks for input about whether certain issuers are more at risk for empty voting, whether rules are needed to require disclosure of decoupling activity, and what the thresholds for that disclosure should be.

In a related vein, the concept release asks for input about how to confirm proxy votes. It floats one idea of its own: that all participants in the voting chain allow issuers, transfer agents, or vote tabulators access to certain information relating to voting records, to let a shareholder or intermediary confirm how shares were voted. Beneficial owners would be assigned some unique identifying code, and that could be used to create an audit trail. The concept release asks about the costs and benefits of sharing such information, about whether shareholders have difficulty in confirming that their votes have been tabulated, and about whether those votes accurately reflect the instructions submitted by beneficial owners.

And the release asks whether agenda items at shareholder meetings should be identified earlier, so that securities lenders can make a decision about whether to recall their lent shares so they can vote them, as well as whether mutual funds and closed-end funds should be required to disclose the number of shares voted at a particular meeting, in addition to how the fund votes.

Other Items to Consider

The concept release also includes many other items for consideration, including:

REQUEST FOR COMMENT

Below are some of the questions the SEC is circulating to the public in its concept release.

… we are considering the extent to which the voting

recommendations of proxy advisory firms serve the interests of investors in informed

proxy voting, and whether, and if so, how, we should take steps to improve the utility of

such recommendations to investors. In particular, we seek comment on whether we

should clarify existing regulations or propose additional regulations to address concerns

about the existence and disclosure of conflicts of interest on the part of proxy advisory

firms, and about the accuracy and transparency of the formulation of their voting

recommendations. Accordingly, we seek commentators’ views generally on proxy

advisory firms and invite comment on the following questions:

Do proxy advisory firms perform services for their clients in addition to or

different from those noted above?

Is additional regulation of proxy advisory firms necessary or appropriate

for the protection of investors? Why or why not? If so, what are the

implications of regulation through the Advisers Act or the proxy

solicitation rules under the Exchange Act? Are any other regulatory

approaches equally or better suited to provide appropriate additional

regulation? Are there regulatory approaches used in connection with

NRSROs that may be appropriate to consider applying to proxy advisory

firms?

Are there conflicts of interest (other than those described above) when a

proxy advisory firm provides services to both investors, including

shareholder proponents, and issuers? If so, are those conflicts

appropriately addressed by current laws, regulations, and industry

practices?

Are there conflicts of interest where a proxy advisory firm is itself a

publicly held company? If so, what are they and how should they be

addressed?

What policies and procedures, if any, do proxy advisory firms use to

ensure that their voting recommendations are independent and not

influenced by the fees they receive for services to corporate clients or

shareholder proponent clients?

Is the disclosure that proxy advisory firms currently provide to investor

clients regarding conflicts of interest adequate? Would specific disclosure

of potential conflicts and conflict of interest policies be sufficient, or is

some other form of regulation necessary (e.g., prohibiting such conflicts)?

Do issuers modify or change their proposals to increase the likelihood of

favorable recommendations by a proxy advisory firm?

Do issuers adopt particular governance standards solely to meet the

standards of a proxy advisory firm? If so, why do issuers behave in this

manner?

Should proxy advisory firms be required to disclose publicly their decision

models for approval of executive compensation plans? Would this

alleviate concerns regarding potential conflicts of interest when issuers

pay consulting fees for access to such models?

What is the competitive structure of the market for proxy advisory firms,

and what are the reasons for it? Does competition vary across the types of

services provided by the proxy advisory firms or the subset of issuers that

they cover? Does the industry’s competitive structure affect the quality of

the recommendations? If there is, as we understand it, one proxy advisory

firm that has a significantly larger market share than other firms, does

that affect the quality of the recommendations made by that proxy

advisory firm or by other proxy advisory firms? Are there any other

effects caused by the fact that there is one dominant proxy advisory firm?

Source

SEC Proxy Concept Release (July 14, 2010).

Proxy distribution fees. Stock exchange rules in place since 2002 set maximum fees a broker-dealer can charge an issuer for forwarding proxy materials to shareholders. In response to concerns about whether that fee structure constitutes “reasonable reimbursement,” the concept release asks whether stock exchanges should revise their fee schedule or even eliminate it entirely, allowing market forces to determine fees.

Communication with beneficial owners. The concept release asks whether the SEC should preserve, eliminate, limit, or discourage the use of “objecting beneficial owner” status, a holdover rule from the 1980s that lets some shareholders withhold their identities from issuers.

Retail investor participation. Participation by individual retail investors has plummeted in recent years, a source of much consternation among the SEC and shareholder activists. The concept release asks for ideas about how to revive flagging participation rates, including improving investor education; enhancing brokers’ Internet platforms; permitting advance voting instructions (known as “client-directed voting”); enhancing investor-to-investor communications, and improving the use of the Internet for proxy material distribution.

Data-tagging proxy-related materials. The SEC began requiring issuers to “tag” information in their financial statements last year using the XBRL data language, to give investors easier ways to find and compare financial data among companies. Based on a recommendation from the SEC’s Investor Advisory Committee, the release asks whether that idea should now be expanded to proxy-related information such as executive pay and director qualifications. (The committee has not specifically called for using XBRL, although that would be the most logical choice.)

Proxy advisory firms. The release asks about whether changes to its rules are needed to require more oversight of and disclosure by proxy advisory firms to allay concerns about potential conflicts of interest and the accuracy and transparency of the formulation of voting recommendations.

Dual record dates. The SEC is requesting comment on whether and how to revise its rules to accommodate dual record dates—which are permitted under state law—to allow companies to set one record date one for determining who receives notice of the meeting, and then another, later date for determining who can vote, to decrease the chances of shareholders who sell after the record date and don’t hold the shares being able to vote.