Last Thursday, the Investor Advisory Committee (IAC) of the Securities and Exchange Commission (SEC) voted to adopt a proposal revised and presented by the Investor-as-Owner Subcommittee (Subcommittee) to recommend modifications to the structure of the proxy process, commonly referred to as “proxy plumbing.” The Subcommittee originally introduced the proposal at an IAC meeting in July 2019, which we previously discussed, but the committee decided to postpone voting on the proposal for further review.
Overview of the Written Recommendations
The revised written proposal proposal largely reflects the original proposal presented at the July meeting. The revised written recommendations are the same four recommendations for “short-term” improvements to the following areas of proxy plumbing: (1) End-to-End Confirmation; (2) Reconciling Ownership and Voting Information; (3) Shareholder Identity and Share Lending; and (4) Adopting the Universal Proxy Rule.
- End-to-End Confirmation
The revised written proposal states that the SEC should require that end-to-end vote confirmations be provided to the shareholders of the company. While the names of the shareholders who actually possess ownership rights (including the right to vote) appear on the company’s shareholder list, many names on the list are holding the interest on someone else’s behalf. Moreover, there can be numerous intermediaries (e.g., banks, brokers and trustees) between the name on the company shareholder list and the person who actually holds the ownership rights (End User).
The IAC proposes that these confirmations verify that the End User’s vote instruction was received and implemented as instructed and, if not, the reason why. To determine the feasibility, the recommendation suggests that the SEC launch a pilot and limit participation in the pilot to the largest companies.
Generally, companies should bear the cost of providing the confirmation; however, in many instances End Users have elected to be largely anonymous (also known as objecting beneficial owners, or OBOs), with limited exceptions such as to the fiduciary with whom the beneficiary owner has contracted. In circumstances involving OBOs, the proposal suggests that the intermediaries that are unwilling or unable to provide the information bear the cost and responsibility. The revised proposal adds that although the IAC believes that the cost will not be significant, the committee proposes that the SEC conduct a cost-versus-benefit analysis before requiring end-to-end confirmations. The minority views relating to costs are provided in the revised proposal, reiterated during the telephonic meeting and discussed below.
- Reconciling Ownership and Voting Information
The IAC recommends that the SEC require all parties involved in the system to cooperate in reconciling ownership and voting information. The IAC believes that conducting reconciliations on a regular basis (not just in the context of specific votes) will aid in continuously uncovering and remediating flaws.
Currently, the SEC rules mandate that transfer agents cooperate with each other to resolve ownership differences. The IAC recommends that the SEC should extend these rules to custodians, banks, brokers, proxy service providers and proxy advisors.
- Shareholder Identity and Share Lending
The proposal explains that some of the complexities of the current proxy system stems, in part, from companies not knowing the identity of all their investors. In addition, at times, share lending among intermediaries can cause a lack of clarity concerning who is entitled to vote, which becomes paramount when vote results are close, such as in a proxy contest.
The written proposal recommends that the SEC conduct a study on each of these topics and give priority to the study relating to shareholder identities. Under the federal securities laws, a client’s identity is not anonymous unless the client expressly objects to the disclosure. Given that a number of proxy plumbing problems are believed to stem from a high number of objections or OBOs, the proposal suggests that the SEC, based on a representative sample, study why customers elect to be anonymous, and the SEC review the contract terms relating to the election. One goal of the study is to determine whether the customer’s choice is due to confusion or incentives of intermediaries to keep their client list private. Another study goal is to determine whether the investor understands how objecting to disclosure of the investor’s name affects lines of communication between the investor and the company.
The other study included in the written recommendation concerns share lending among entities such as banks and brokers. When shares are loaned, the ownership right stays with the lender, but the right to vote temporarily transfers to the borrower until the share is returned. Depending on the dates and duration of the contract governing the loan, the record holder may differ from the person who has the right to vote. The written proposal recommends that the SEC study whether share lending contributes to errors and whether adequate disclosure is provided to investors regarding lending practices and processes. The study should include a survey of the relevant terms of a representative group of contracts. In addition, for a better understanding, the SEC should also review the relevant processes of companies with loan arrangements involving a significant number of shares. Finally, the SEC should determine whether loaned shares are consistently recalled to be voted.
- Adopting the Universal Proxy Rule
Under the current system, in a proxy contest there are two slates of director nominees—one recommended by the company and the other recommended by the dissident. Only persons attending the shareholder meeting can vote for director nominees regardless of on which slate the candidate’s name appears. Stated differently, names can be selected from more than one slate. In contrast, votes by proxy, which are done for a large number of shares, must select candidates from the same slate.
The main purpose of universal proxies is to extend the same voting flexibility to voters by proxy that is currently enjoyed only by voters who attend the meeting—the ability to choose a candidate regardless of who nominated that candidate. Equally important, the committee states that universal proxies will reduce costs to the company and dissidents and improve the vote tabulation process.
The IAC recommends that the SEC should adopt the SEC’s 2016 proposed universal proxy rule with the modest changes that may be needed to address objections that have been raised to that proposal. These objections include the percentage of shareholders a dissident is required to solicit. The 2016 SEC proposal suggested 50%, which the IAC notes could be raised (e.g., to 67%). In addition, the recommendation states that some commenters expressed objections regarding certain costs to dissidents. The recommendation notes that the responsibility for the costs may be dictated by state law. Also, the objection that an incumbent may refuse to serve is always a possibility, even under the current system, and may be addressed by disclosing this risk to shareholders.
According to the IAC, the number of trade associations and companies that were once concerned that universal proxies may encourage proxy contests and favor dissidents has diminished in light of studies that have been conducted since the 2016 SEC proposal showing otherwise.
Overview of Telephonic Meeting; Dissenters
SEC Chair Clayton and Commissioner Jackson presented opening remarks. Chair Clayton stated that proxy voting generally is considered important, and that investment advisers must exercise the voting responsibilities in the best interests of their respective clients. He also mentioned the recent SEC guidance relating to how an investment adviser’s fiduciary duty and Rule 206(4)-6 under the Investment Advisers Act relate to an adviser’s proxy voting on behalf of its clients. In addition, he referenced another SEC guidance and its related interpretation concerning that the proxy voting advice provided by proxy advisory firms generally constitutes a solicitation under the federal proxy rules.
Both Commissioners expressed concern regarding the decline in voter participation by Main Street investors holding shares directly and the degree to which their participation may relate to the proxy process.
While the general sentiment remained favorable during the telephonic meeting, the two dissenters voiced objections. One dissenter opposed mandating the use of universal proxies even in limited circumstances. The IAC proposal supports the SEC’s 2016 proposal which, if adopted, would mandate the use of universal proxies for contested proposals. The member expressed that the use of universal proxies should always be voluntary. In addition, the dissenter objected to mandating end-to-end confirmations for all proposals without first establishing that the benefit outweighs the financial cost. Given that the vote results are not close for most proposals, the dissenter questioned the value of burdening the system with the cost of end-to-end confirmations and believed requiring end-to-end confirmations, if imposed, should be reserved or limited as necessary, such as only for proxy contests.
Another dissenter questioned the degree to which the adopted proposal seeks SEC intervention because market participants may arrive at a solution on their own without any governmental action. The dissenter further remarked that the SEC’s establishment of more rules could further contribute to rather than alleviate problems. Accordingly, greater focus should be on identifying and eliminating / reducing existing rules.
Additionally, criticism was voiced that the proposal’s approach is too piecemeal. Because the proxy system has interrelated parts, the member suggested that a more comprehensive approach would be better. Examples of related topics specifically raised were conflicts of interest of proxy advisors as well as problems stemming from shareholder proposals that are politically motivated. With regard to this criticism, a Subcommittee member rebutted that while the Subcommittee understood this concern, given the complexity of the proxy system, the Subcommittee at this juncture chose to select items that were actionable, and envisioned that the review of the system and the potential changes to it would occur over a span of years.
No indication was given of the likelihood of the SEC implementing any of the four recommendations.