Few would argue that proxy voting is a bad thing. Most see the ability to participate in corporate governance matters as important for both investors and to companies.
Here, however, is the catch: Only a relative handful of shareholders will travel to attend shareholder meetings in person. The long-established, continually debated proxy system was designed to give investors the ability to remotely vote, submit proposals, and otherwise make their views known to management on such important matters as director elections, say on pay, and proposals that more frequently are demanding initiatives and action on social, political, and environmental concerns.
Many of the fundamental concerns about shareholder engagement are once again coming to a head. SEC Chairman Jay Clayton announced recently that his staff will host a roundtable on Nov. 15, “to hear investor, issuer, and other market participant views about the proxy process and rules.”
The roundtable will focus on key aspects of the U.S. proxy system, including proxy voting mechanics and technology, the shareholder proposal process, and the role and regulation of proxy advisory firms.
With just a little over a month to go before the event, multiple sides of multiple proxy-related issues are jockeying for public awareness and support.
Limiting interpretive guidance
Among the matters expected to be hotly debated is the recent SEC decision to withdraw two 2004 “no-action” staff letters, issued at the time to governance and proxy advisers Egan-Jones Proxy Services and Institutional Shareholder Services. The letters, critics say, have long allowed asset managers to skate past potential conflicts of interest by using third-party recommendations when casting annual meeting votes on behalf of shareholders who invest through their firm or its funds.
Others, however, are more than skeptical about the motivation and timing of the move. Among those questioning it is Rep. Carolyn Maloney (D-N.Y.). She challenged the decision during a Sept. 26 hearing of the Financial Services Committee that questioned Dalia Blass, director of the SEC’s Division of Investment Management.
Maloney asked why a “system that had worked well for 14 years” was done away with “suddenly and without any explanation.”
“The only reasons the SEC cited were non-specific,” she said. “This is concerning. It is unclear why the SEC needed to withdraw two no-action letters that have been extensively relied upon for years simply to facilitate discussion about proxy advisors. Surely it was possible to have a robust discussion about this without suddenly withdrawing the guidance that the markets have been observing and relying on for years.”
“It is unclear why the SEC needed to withdraw two no-action letters that have been extensively relied upon for years simply to facilitate discussion about proxy advisors. Surely it was possible to have a robust discussion about this without suddenly withdrawing the guidance that the markets have been observing and relying on for years.”
Rep. Carolyn Maloney (D-N.Y.)
Blass reiterated that the move was indeed intended to foster discussion at the roundtable.
“We have been undertaking a full review of all guidance issued by the division,” she said. “This is part of modernizing our regulatory framework to see which guidance should be amended, rescinded, or supplemented as we look at market developments.”
Among the changes since 2004, she said, were the rapid growth of registered fund assets, the increasing voting power of institutional investors, the prominence of passive investors in index funds and related products, and the rise of new technologies.
“What hasn’t changed is that this is fundamentally about how shareholders exercise their rights. The proxy firms are a very important part of this ecosystem,” Blass said. “We wanted to focus on discussing these issues, which are really important to shareholders in the upcoming roundtable to see what changes, if any, should be made. Given how much ‘airtime,’ rightly or wrongly, these two letters have received, we determined that the best course of action to make sure the best way to get robust discussion at the roundtable would be to withdraw them.”
What’s wrong and how to fix it
A broader discussion of proxy voting took place during last month’s regular meeting of the SEC’s Investor Advisory Committee (during which Clayton announced the rescission of the two interpretive letters).
Among those offering their views were Ken Bertsch, executive director of the Council of Institutional Investors. “Investors seek a proxy voting system that is timely, accurate, transparent—including routine end-to-end vote confirmation—and efficient,” he said.
He urged better uses of technology to help improve the proxy voting process. “It is time to look seriously at use of private blockchains, system-wide, operated by trusted third parties,” he said.
The current system of proxy voting “is fraught with inefficiencies and a too-large margin for error,” Bertsch explained. “Between the complexity of intermediary chains and challenges around fungible shares, many of our members have and continue to lack confidence that their shares are always fully and accurately voted.”
For example, institutional investors typically vote on electronic platforms and should, in a perfect world, routinely and promptly see vote confirmations both on how shares in an account were voted on each voting item, and the number of shares voted. Since 2010, market intermediaries have worked on a system to provide vote confirmation on request.
“But progress has been halting, and this system seems to work only when the stars are aligned, with cooperation between various intermediaries,” Bertsch said. “Vote confirmation has not become routine, efficient, or easy.”
Meanwhile, in Washington ...
Institutional Shareholder Services (ISS) and CII recently launched a website, protectshareholders.org, to oppose legislation, H.R. 4015. The Corporate Governance Reform and Transparency Act would require proxy advisory firms to: register with the SEC; disclose potential conflicts of interest; and make publicly available their methodologies for formulating proxy recommendations and analyses.
The new group says the bill “would undermine the independence and business of proxy advisory firms that provide reports to institutional investors on matters that are to be voted on at public company annual meetings.”
The legislation, by giving companies the right to review proxy advisors’ research reports before they go to investor clients, “gives investors less time to review them, potentially skewing the reports in favor of management,” they add.
The U.S. Chamber of Commerce is also weighing in on the overall proxy debate, with this week’s publication of two related reports by its Center for Capital Markets Competitiveness.
The first report, its fourth annual proxy season survey, was compiled jointly with Nasdaq.
According to the survey, while companies are bringing more issues to the attention of proxy advisory firms, “they still find it difficult to engage in constructive discussions that lead to better-informed voting recommendations.” Of the 165 companies that participated in the survey, only 39 percent said they believe proxy advisory firms “carefully researched and took into account all relevant aspects of the particular issue on which it provided advice.”
Two proxy firms—Institutional Shareholder Services (ISS) and Glass Lewis—control roughly 97 percent of the proxy advisory industry, “constituting a duopoly that have become the de factostandard setters for corporate governance in the U.S.,” the report says.
Another perceived problem with the proxy advisory system, as detailed in the survey: a trend toward “robo-voting,” where a company’s outstanding shares are voted in line with an ISS or Glass Lewis recommendation in the 24-hour period after the recommendation is issued.
A separate Chamber report looks at “zombie” proposals—those that are submitted three or more times without garnering majority support. It argues for raising the resubmission thresholds established by the SEC under its Rule 14a-8.
“Unfortunately, this system has turned into one that is largely dominated by a small minority of activists that increasingly target American businesses over social or politically-charged issues,” the report says. “Compounding the problem, current SEC rules allow proposals that have received very low support to be resubmitted year after year, even if a vast majority of shareholders continually vote against them.”
This, the Chamber says, “poses enormous costs not just in terms of corporate resources spent to deal with proposals every year, but also in terms of the distractions they create for management and boards, which have a duty to focus on the long-term best interests of the company.”
These proposals “increasingly deal with social or political matters that most shareholders deem immaterial to their decision making,” the Chamber argues. The Manhattan Institute’s Proxy Monitor Report found that, in 2017, 56 percent of shareholder proposals at Fortune 250 companies dealt with social or policy concerns.
From 2006 to 2016, Fortune 250 companies received 445 proposals dealing with political spending disclosures. Only one of these proposals during that time frame received majority backing, and in most years, proponents failed to garner the support of more than 20 percent of voting shareholders, the report says.
The Chamber argues that “the most meaningful reform the SEC could undertake would be to raise the resubmission thresholds that determine when proposals that receive a low amount of shareholder support may be resubmitted in a subsequent year.
Current SEC rules state that companies may only exclude a proposal from its proxy materials if it failed to gain:
Less than 3 percent support on the previous submission if voted on once within the previous five calendar years;
Less than 6 percent support on the previous submission if voted on twice within the previous five calendar years; or
Less than 10 percent support on the previous submission if voted on three or more times within the previous five calendar years.
This, the authors point out, means that, current SEC rules can allow a proposal that received nearly 90 percent opposition in multiple years to be continuously resubmitted.
“In other words, the current shareholder proposal system allows the ‘tyranny of the minority’ to prevail at the expense of Main Street investors,” the report concludes.
A private blockchain, viewable only by the company, its shareholders, and designated proxies—and permissioned, meaning only a trusted gatekeeper can enter its content, could help resolve these and related problems, he argues. The blockchain would record each of the company’s beneficial owners and their holdings as of a predetermined record date. This determines each shareholder’s entitlements—for example, their voting rights, right to view proxy materials, or right to submit a shareholder proposal subject to ownership thresholds. Neither the company nor other shareholders would be able to see the identities or holdings of any individual shareholder.
Under CII’s plan, as a meeting of shareholders approaches, the gatekeeper can upload the company’s proxy materials on the blockchain for shareholders to view. Once information is entered, it cannot be changed or removed—only added. “This promotes transparent, far less expensive recordkeeping and ensures that all eligible shareholders can access the materials instantaneously and simultaneously,” Bertsch said, adding that such a system would improve vote allocation and authentication.
The U.S. voting infrastructure “is outdated,” and the time has come to develop a proxy voting regime for the 21st Century, noted David Katz, a partner at law firm Wachtell, Lipton, Rosen & Katz whose practice increasingly deals with shareholder activists, contests for corporate control, and proxy contests.
“The current proxy voting infrastructure was developed for a different era and has not been updated to address fundamental market and technological changes,” he explained. While there is SEC oversight, it “regulates with rules and tools that were developed long before e-mails, faxes, texts, and the internet were even a glimmer in anyone’s eyes.”
A common refrain, one Katz raised as well, is “the undue influence of proxy advisory firms such as ISS and Glass Lewis, to whom many institutional investors outsource their proxy voting decisions.”
While a number of major institutional investors “have taken their proxy voting decisions back in-house, most institutional investors, either for cost reasons or otherwise, have not abandoned the proxy advisory outsourcing model,” he explained. The proxy advisory firms “do not provide equal access to issuers as they do to investors (particularly shareholder activists) and these firms need separate regulation.”
The current system, Katz said, leads to significant costs for both sides. It has been reported that an ADP/Pershing Square proxy contest (where a hostile takeover by the latter of the former was squashed by shareholders who rejected efforts to repopulate the board of directors) cost more than $26 million, $24 million of which was borne by ADP and, ultimately, its shareholders.
Proctor & Gamble’s effort to keep activist investor Nelson Peltz of Trian Fund Management off its board was the most expensive proxy contest on record, totaling roughly $100 million (although, a tie in shareholder votes eventually led to a compromise where he joined the board anyway).
“When every vote counts, each vote gets expensive,” Katz said.
In its 180-year history, P&G (like most companies) had never faced a proxy contest—until last summer,” added Deborah Majoras, Procter & Gamble’s chief legal officer.
She explained the shareholder complexities uniquely affecting her company.
P&G has more than 2.5 billion outstanding shares, which are held by about 3 million shareholders. Of those, about 40 percent are retail shareholders, double the size of most companies.
There is “the fundamental challenge of engaging retail shareholders who may not understand the importance of voting,” Majoras said. With retail turnout typically around just 25 percent, “we should examine whether we can do more to convince them that their votes matter.”
“If we want retail shareholders to vote, we must give them a convenient and user-friendly method by which to vote,” she added. Online voting “works fairly well,” but only if the shareholder can log in. While control numbers are included in mailings, shareholders often misplace or accidentally discard them. Replacing them is not easy as it could be.
“In an age when many consumers do everything online, from banking to purchasing a car, we must find a more efficient yet secure way for shareholders to vote their shares,” Majoras said.
There must also be an accurate vote count, a task complicated because voting inspectors still rely on highly manual processes and subjective judgments.
“With tens of thousands of cards to be sorted and tabulated, errors are inevitable,” Majoras said. “We know from experience that a group of rubber-banded ballots might be overlooked or some ballots may be stuck together and not counted. When you combine the issues caused by physical proxy cards with the many broker voting issues that exist, guaranteeing a timely and fully accurate vote count is virtually impossible.”
Early in this “painstaking tabulation process,” she said, the inspector is required to issue a preliminary report. That report—by definition, as it is “preliminary”—will have errors; it will not be the final vote count. Nevertheless, SEC rules require issuers to file an 8-K and publish this preliminary report.
“In a close election, this report can create needless and even harmful swirl,” Majoras said. “In our case, many shareholders did not even realize that the report was not final, because many media stories failed to clearly make that distinction. While shareholders are absolutely entitled to information, that information should be accurate, and the publication of a draft report in a contested election is not helpful.”