United States: SEC's Investor Advisory Committee Adopts "Proxy Plumbing" Recommendations

Yesterday morning, at a telephonic meeting of the SEC's Investor Advisory Committee, the Committee voted to adopt revised recommendations addressing "proxy plumbing"—the panoply of problems associated with the infrastructure supporting the proxy voting system. (See this PubCo post.) The recommendations were originally presented at a meeting of the Committee in late July, but the Committee elected to study the proposal further and offer revisions before voting. The changes are fairly nuanced, now also including some minority views. For the most part, the recommendations would not "reinvent" the proxy voting system, instead targeting improvements that are considered essentially "low-hanging fruit." However, there appeared to be a consensus that eventually more would need to be done. The recommendations were adopted by a majority of the Committee with two dissents. Will the SEC pay attention?

SEC Chair Jay Clayton opened the meeting by reminding the Committee of the SEC's recently issued guidance regarding investment advisers' fiduciary duty and proxy advisory firms' potential liability for fraud (given that the role of proxy advisory firms is part of the proxy plumbing conundrum). He also reminded the Committee of the questions that he views as important to consider in examining proxy plumbing:

Commissioner Jackson also highlighted the falling level of participation in voting by retail shareholders.

Shareholder voting is viewed as fundamental to keeping boards and managements accountable, and according to the recommendations, every year, billions of shares are voted at more than 3,000 shareholder meetings of public companies. However, it is widely recognized that the current system of share ownership and intermediaries is a byzantine one that accreted over time and certainly would not be the system anyone would create if starting from scratch. There is also broad agreement that the current proxy plumbing system is inefficient, opaque and, all too often, inaccurate. As the recommendations observe, under the current system, shareholders "cannot determine if their votes were cast as they intended; issuers cannot rapidly determine the outcome of close votes; and the legitimacy of corporate elections, which depend on accurate, reliable, and transparent vote counts, has been called into doubt." In 2010, the SEC issued a proxy plumbing concept release, but no action was taken as a result. (See this Cooley News Brief.) However, in the last year or so, proxy plumbing has reemerged as a serious problem to be addressed. The Committee took up this issue about a year ago and, at the SEC's proxy process roundtable last year, proxy voting mechanics were actually a hot topic—described by one panelist as "the most boring, least partisan and, honestly, the most important" of the roundtable topics. For a discussion of the issues comprehended by the concept of "proxy plumbing," see this PubCo post, this PubCo post and this PubCo post.

(The following paragraph is based on my notes, so standard caveats apply.) While the basic framework of the recommendations remains the same, in the introduction, the Committee appears to have reached a conclusion on open issue: could the problems surrounding proxy plumbing be addressed through private ordering or other private action? Apparently, the conclusion is no, as the Committee added an express statement that they "do not believe private actors will improve the system without SEC intervention." That addition led, in part, to one Committee member's dissent. (Apparently, she viewed SEC intervention as part of the problem, not part of the solution.) Another Committee member dissented because, while he viewed some aspects of the proposal as helpful, he viewed all of the components of proxy plumbing as interrelated and considered the omission of recommendations regarding proxy advisory firms (and their conflicts of interest) and the shareholder proposal process (which he viewed as too flawed and too often politically motivated) as terminal. In addition, this dissenter thought that the recommendations went too far in recommending mandatory universal proxy, as opposed to simply removal of barriers to its implementation. Professor John Coates, who authored the recommendations, acknowledged that there was more work to do, but contended that those other issues were more politically charged and, as a result, a bigger lift; in his view, these recommendations were more likely to accepted without substantial dissension. Note that Coates discussed only three recommendations, excluding the recommendation that the SEC conduct various studies, but the posted revised recommendations continue to include the recommendation for SEC studies.

Recommendations

Vote confirmations. "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." Shareholders tend to assume their shares have been voted, but that may not really be the case. As a basic matter, investors should have the ability to see through the chain of intermediaries to confirm that their shares have been voted as directed, but it's often difficult or impossible for them to do so. This problem is exacerbated by the practice of share lending, and there is apparently little transparency regarding share lending practices.

The recommendations suggest that the SEC require that confirmations be sent to each individual or institution with final voting authority over any shares indicating that the shares were voted as instructed and, if not, the reason why not. The recommendations argue that this information "would increase confidence in the proxy system and provide incentives for those involved to eliminate routine problems that prevent proxies or voting instructions from being implemented as shareholders direct. Inquiries from investors when instructions are not implemented will organically generate root-causes analyses of the reasons for that failure. Those analyses will provide the foundation for a continuous cycle of system improvements over time." Initially, issuers would pay the costs, but costs "should shift to intermediaries who are unable or unwilling to provide investor identification to companies.... Intermediaries would have an affirmative reason to persuade 'objecting' clients to become NOBOs, permitting companies to communicate directly with the investors." The recommendation also indicates that "Broadridge has created a method for institutional investors to use an online end-to-end voting system, which allows for confirmations of votes. Uptake on the system has been slow, however, and it is currently not used by individuals." Nevertheless, the viability of the Broadridge confirmation system corroborates the technological feasibility of end-to-end confirmations under the current proxy system. The Committee added a recommendation that the SEC conduct a standard cost-benefit analysis. A minority of the Committee voiced concerns regarding costs and suggested that the SEC consider whether costs could be limited by requiring confirmation only in certain cases, such as contested elections.

Reconciliations. "The SEC should require all involved in the system to cooperate in reconciling vote-related information, on a regular schedule, including outside specific votes, to provide a basis for continuously uncovering and remediating flaws in the basic 'plumbing' of the system." The current system of share immobilization exacerbates the problem of counting shares. Under that system, most shares are held in street name and reflected in positions listed at a centralized depositary (DTC), where they are treated as a "fungible mass of shares not traceable to any individual." While the system makes share transfers easier, the arrangement is itself complex, compounded by many layers of intermediation—the transfer agent, the custodian and perhaps several subcustodians—that can complicate and obscure proxy voting and lead to mismatches that ultimately disqualify votes. Currently, various laws require system participants to maintain accurate books and records, but these obligations vary and they may not always be enforced. The SEC should "require every participant in the proxy system to cooperate with the others to reconcile ownership and voting information on a regular basis, both during and outside the context of specific votes. This requirement would track the existing requirement applied to transfer agents, but would be extended to custodians, banks, brokers, proxy servicers and proxy advisors."

Studies. "The SEC should conduct studies on (a) investor views on anonymity and (b) share lending." In light of the inability of companies to communicate directly with shareholders categorized as "objecting beneficial owners," the goal of the first study would be to find out whether so many investors really want to be anonymous or whether they choose to be OBOs due to confusion or incentives of intermediaries. For example, are investors confusing anonymity as an investor with anonymity as a proxy voter? A related question would be to "determine the extent to which the nominal default rule—by which broker customers are treated as NOBOs unless they object—has been 'flipped' in broker contracts," perhaps without the knowledge of the customer.

The second study would be designed to understand the extent to which share lending "contributes to errors, over-votes or under-votes, and whether the effect of share lending on voting entitlements is effectively disclosed to investors." For example, custodians generally can't vote shares that have been lent out and are not on their books on the record date, and yet the custodians may not directly receive information about the record date on a sufficiently timely basis to recall the shares in order to vote them. Similarly, shares transferred after the record date are often not voted or voted inaccurately. How are votes associated with shares on loan processed and counted? How do those counting the votes verify that there is no overvoting or undervoting of lent shares? Are shares on loan consistently recalled for votes?

Universal Proxy. "The SEC should adopt its proposed 'universal proxy' rule, with the modest changes that would be needed to address objections that have been raised to that proposal." Universal proxy is a proxy card that, when used in a contested election, includes a complete list of board candidates, thus allowing shareholders to vote for their preferred combination of dissident and management nominees using a single proxy card. In the absence of universal proxy, in contested director elections, shareholders can choose from both slates of nominees only if they attend the meeting in person. Otherwise, they are required to choose an entire slate from one side or the other. Because a later-dated proxy revokes an earlier-dated one under state law, it's not easy to split votes between slates. While historically, most companies have opposed universal proxy, more recently, a consensus has developed about the potential value of universal proxy cards in proxy contests, as some issuers have apparently recognized that universal proxy could, in some cases, help the management slate. (See this PubCo post.) In 2016, the SEC proposed amendments to the proxy rules that would have mandated the use of universal proxy cards in contested elections, but nothing came of the controversial proposal—at least not yet. (See this PubCo post.)

In its recommendations, the Committee contended that "universal ballots would reduce the confusion, costs and burden on investor-voters associated with the current system, which typically involves delivery of multiple (often duplicative) proxies throughout a contest. The current system also requires careful attention by the tabulator and others involved to make sure that the 'last' submitted proxy with respect to a given share is identified and counted as the valid vote." The Committee recommended that the SEC modify the 2016 proposal to increase—from 50% to perhaps 67% or more—the percentage of shareholders that dissidents would be required to solicit to be able to use universal proxy. With regard to the argument that the proposal should mandate a "level playing field" with companies, the recommendation contends that the company's solicitation on behalf of the incumbent is routinely paid by the company, but dissidents are reimbursed only if they win or otherwise reach a settlement with the company. In addition, if the company knows that some incumbents may refuse to serve if elected to a split slate, that should be required to be disclosed (although, the recommendation notes, there is always a risk that a director may choose not to continue on a board for any reason). A minority of the Committee would have recommended making universal proxy voluntary rather than mandatory, consistent with a 2013 Committee recommendation, allowing both companies and dissidents to choose. For this concept, the SEC would need to amend its rules "to remove obstacles to the use of universal proxy cards, but the use of that proxy card in practice would depend on private ordering."

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