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Paul Hodgson: There’s more to the SEC Investor Advisory Committee recommendations than just securities lending

Looking into the detail of last month’s recommendations by the SEC Investor Advisory Committee

While its recommendations to direct SEC to look at securities lending rightly made for a news story in Responsible Investor, there were a lot of other aspects to last month’s recommendations by the SEC Investor Advisory Committee (IAC) on how to fix “proxy plumbing” last month that also merit attention.
The Committee made four specific recommendations:

1. That the SEC should “require end-to-end vote confirmations to end-users of the proxy system, potentially commencing with a pilot involving the largest companies”
2. That it should require all participants to cooperate during and outside proxy season in reconciling votes to help uncover and fix flaws in the system;
3. As well as share lending, investor views should be canvassed on anonymity;
4. Adoption of a proposed universal proxy rule.

Over 600bn shares are voted every year at more than 13,000 shareholder meetings in the US, and currently this system is unreliable.
Shares, says the document outlining the committee’s recommendations, “are commonly owned in ‘stacks’ or chains of contracts, which involve intermediaries or agents such as custodians, broker-dealers, banks, and transfer agents”.
This system prevents the first recommendation – end-to-end vote confirmation. “The primary goal of the proxy system,” says the IAC, “should be to provide accurate, timely and cost-effective vote counts.”
Unfortunately, this is not the case. Most elections or other issues on which shareholders vote do not result in a close vote. Because of this, “inaccuracies can exist without having a direct and significant effect on the outcome under corporate law so participants are not incentivised to fix the system”.
But there are some close votes every year, so companies and investors should have a significant collective interest in a reliable system. Some of the problems that occur when a close vote happens include: “hand counts, recounts, litigation, negative publicity, delay, and acrimony”.

“Litigation, negative publicity, delay, and acrimony.”

“Worse,” says the IAC, “publicity associated with inaccurate or slow vote counts undermines the legitimacy of other votes, of corporate governance as a whole, and of US equity markets generally”.
The IAC also points to research that such problems also raise the cost of capital and reduce liquidity.
The IAC then recounts the story about the T. Rowe Price votes in the buyout of Dell (RI coverage).
And then it comes to its final problem with the current proxy system, its opacity. Investors can’t tell if their shares were voted as intended; and in contested votes, lots of votes are disqualified due to mismatches or other recordkeeping errors. Broadridge, which has a 90% market share in the system, has created a system for institutional investors which allows for vote confirmation, but there has been very little uptake.The IAC notes that comprehensive reform is likely to be achieved through improved technologies such as distributed ledger technology (i.e. blockchain).
Blockchain offers a way to create a unified external platform that can be available securely to all participants in the proxy system. There is also a way to deal with the OBO/NOBO (objecting and non-objecting beneficial owners, the former wish to remain confidential) system with blockchain.

Privacy can be guaranteed through the use of nominee accounts. The IAC notes that it is not technological problems that are impeding the reform of proxy plumbing but “incentives and private interests (as affected by existing regulation), coupled with the externalities of networks”. Nor are there legal impediments. Companies are already allowed by both state and federal law to opt into share ownership and/or the vote confirmation systems, including by using blockchain.
Broadridge’s dominance, says the IAC, “reduces competitive pressure to enhance cost-effective service”. The committee says that the current system “combines the worst attributes of a government-sponsored near-monopoly (inertia, poor incentives, lack of competitive market pricing) with the worst attributes of a disaggregated non-centralized market (confusion, duplication, complexity, errors)”.

The first recommendation – vote confirmation – could be achieved using the current Broadridge system for those investors who invest through intermediaries. For direct investors, transfer agents could provide confirmation. For direct investors, the costs and responsibility for confirmation should be companies’ responsibility. For intermediary investors, because companies do not have the ability to communicate with investors directly because of the NOBO rules, costs “should shift to intermediaries who are unable or unwilling to provide investor identification to companies”.
As to the second recommendation, transfer agents are already required to reconcile ownership and voting information regularly, during and outside proxy season. This requirement should simply be extended to custodians, banks, brokers, proxy servicers etc.
The committee also asks SEC staff to survey investors about why, and to what extent, the customers of “actually want to remain anonymous” to the companies in which they own stock. While anonymity is still possible, it may not be necessary and such a survey should be used to establish this.
To come to the final recommendation, there are a couple of problems with the SEC’s existing universal proxy or ballot rule. For example, any rule needs to address what percentage of shareholders dissidents must solicit to be able to use a universal proxy. The SEC’s initial proposal in 2016 was 50%. But many have raised objections to this, and the IAC recommends that the percentage should be raised to, for example, 67%.
The whole proxy process issue is up for discussion on a “telephonic meeting” on September 5.