How Stocks are Voted
Owners of public companies are entitled to vote on certain corporate matters, such as the election of directors and major corporate actions. State law generally defines what rights they enjoy as stockholders. As a practical matter, many investors are not able to attend shareholder meetings and cast their votes in person. However, state law and a company's charter require a minimum percentage of shares that must be represented at a shareholder meeting before business can be legally conducted. To meet this quorum requirement, public companies issue a request for proxies, to obtain the votes of owners who are not able to attend a meeting in person.
State law provides that the legal owners of stock vote the shares or grant a proxy to vote the shares at a shareholder meeting. Accordingly, beneficial owners who hold shares in street name are not entitled to vote their shares or grant proxy authority. Instead, beneficial owners must provide voting instructions to those street-name entities holding legal title to their shares.
Under section 14 of the Securities and Exchange Act of 1934, the U.S. Securities and Exchange Commission (SEC) is charged with the responsibility of regulating the proxy soliciting process in order to ensure "fair corporate suffrage" for every stockholder. The SEC is also responsible for ensuring that each stockholder has "adequate knowledge as to the manner in which his interests are being served." In enacting the 1934 Act, Congress granted the Commission the authority to promulgate "such other rules and regulations ... necessary or appropriate in the public interest for the protection of investors."
A description of what Congress intended the SEC to accomplish in proxy voting and related matters can be found in the Committee reports drafted by the House and Senate when the Act was passed in 1934. Copies of these Committee Reports on the 1934 Act can be accessed below.
Under the street name system, the vast majority of investors own stock as beneficial owners. Legal title and ownership of individual shares reside with a depository institution, such as the Depository Trust Company (DTC). When a public company seeks to hold a shareholder meeting, it notifies DTC, as the record holder for most of the stock shares held in street name. A record date is established to identify the current shareholders as of that date who may vote at the shareholder meeting. DTC then issues an "omnibus proxy" to the brokers, banks, and other institutions holding securities in street name, granting them the authority to vote proxies at the upcoming meeting.
For each shareholder meeting, beneficial owners receive proxy materials, including information about the issues to be voted on at that meeting. Beneficial owners also receive a voting instruction form (VIF) that is to be used by them to indicate their voting preferences. Beneficial owners then return this VIF for processing by a broker or a bank, or its representative.
Over the years, the shareholder voting process has been constructed in a piecemeal basis. To understand the complexity of the current system, click on the link here or below for a flow chart describing the multiple steps and intermediaries involved in the current system.
A 2010 federal court decision involving the eligibility of a beneficial owner to submit a shareholder proposal provides an excellent description of the multiple layers of financial intermediaries between a public company and its individual investors. Click on the link here or below for the court decision in Apache Corporation vs. Chevedden, issued on March 10, 2010.
The Role of Broadridge Financial Solutions (formerly ADP)
Brokers, banks, and other institutions generally outsource all proxy administrative functions, including the forwarding of proxy materials to beneficial owners and the receipt and tabulation of voting instructions from these same owners. One company, Broadridge Financial Solutions (Broadridge), generally provides these services and is used by the substantial majority of these financial institutions. Broadridge provides other back office services to some of these financial institutions, in addition to proxy services.
Public companies pay for the proxy processing services provided by these third parties, even though they exert little to no control over the services that are actually provided. The fees for proxy processing services are approved first by the New York Stock Exchange (NYSE) and, later, by the SEC.
Click here for a link to Broadridge's website to learn more about the services it offers.
Since public companies pay for these services--and brokers and banks select Broadridge as their service provider--there very few incentives in the system to improve its efficiency or reduce costs.
The Role of Broker Discretionary Voting and NYSE Rule 452
Under New York Stock Exchange (NYSE) Rule 452, a broker may vote on certain "routine" matters, if a beneficial owner fails to return his or her VIF at least ten (10) days before a shareholder meeting. This Rule does not apply to contested matters or to any matter which may affect substantially the rights or privileges of a stock holding. Click here to review a copy of NYSE Rule 452.
In 2009, the SEC accepted a NYSE rule proposal to eliminate the ability of a broker to vote shares in any election of directors, if a VIF is not submitted in a timely manner. One of the consequences of this Rule change is that it will be harder for a public company to reach a quorum in a shareholder meeting if there isn't any routine matter on the ballot.
The Problems Caused By Share Lending Practices
When shares are lent out by brokers, both long and short investors of the same security may receive a VIF for voting. Even though the right to vote generally rests with the investor who possesses the shares on the record date, brokers may not know which votes they are entitled to cast in a corporate election. Votes that are submitted for a corporate election are compared to the aggregate number of shares held in a financial institution's account at DTC or at another share depository. If the number of votes cast is not equal to the institution's share position at these depositories, the broker is responsible for developing procedures to reconcile any discrepancies.
In 2006, the securities industry adopted guidelines to address this proxy processing issue. A copy of these 2006 guidelines is also posted below.
This reconciliation problem is primarily caused by share lending of these security positions. While Broadridge and the brokerage community are working on solutions to address this problem, a consensus approach has not been developed.
The Barriers to Shareholder Communications
For many years, public companies have been critical of the SEC's shareholder communications rules for the proxy solicitation process. The use of multiple layers of intermediaries has created artificial barriers between public companies and their shareholders. As far back as the 1970's, public companies were urging the SEC to permit direct communications with beneficial owners for the purpose of proxy voting.
The current SEC rules permit the disclosure of the name, address (or contact information), and number of shares registered in the name of the broker or bank for any beneficial owner who does not object to such disclosure. This type of beneficial owner is called a Non-Objecting Beneficial Owner ("NOBO"). Any beneficial owner who does not want to have direct communication with a public company that he or she invests in is called an Objecting Beneficial Owner ("OBO").
Technological advances since the 1970's should permit direct communications between a public company and its beneficial owners. Under this type of system, companies would receive a list of all beneficial owners as of a record date and would be permitted to send proxy materials directly to them, with appropriate follow-up communications as necessary via electronic means, the mail, or by telephone.
A direct communications system avoids having to send proxy materials through brokers, banks, and other intermediaries, enabling companies to communicate with their shareholders in a more efficient and cost-effective manner. Shareholders who desire to remain anonymous would be permitted to do so through the establishment of nominee accounts, but would do so at their own expense.
The Need to Reform the Shareholder Voting and Communications System
The SEC needs to update and modernize the U.S. shareholder voting and communications system. Any reforms should include the following principles and recommendations:
1. Direct Communications with Individual Investors. The SEC should eliminate the NOBO/OBO distinction, to give public companies' access to contact information for all of their beneficial owners and permit companies to communicate with them directly. Shareholders who want to remain anonymous should bear the cost of maintaining their privacy, by establishing nominee accounts or by similar means.
2. Voting By Retail Investors. The SEC should examine how to protect the vote of the retail investor, particularly in the case of unvoted shares.
3. Competition among Proxy Service Providers. Brokers, banks, and other intermediaries should not stand in the way of direct communications between public companies and the beneficial owners of their securities. Companies should have the ability to determine the distributors of their communications by choosing among several different service providers. Companies also should not be forced to pay for the costs of a system in which the fees and the service providers are determined by third parties.
4. Proxy Voting Integrity. The SEC should consider additional steps to ensure that the proxy voting system is transparent and verifiable. In this regard, the SEC should examine its ownership disclosure requirements and consider requiring disclosure of both voting and economic ownership along with both positive and negative economic ownership.
5. Proxy Advisory Services. The SEC should review the role of proxy advisory services and the procedures used by these firms in generating recommendations.
Any reforms to the proxy voting system should identify problems and suggest solutions for both companies and shareholders. And any improvements to the ability of a public company to identify and communicate with its shareholders should also be available to shareholders wishing to communicate with other shareholders.