Deep differences of opinions still exist over the idea of abolishing broker-dealers’ power to vote in elections for corporate board directors, despite a revived push by the New York Stock Exchange to end the practice once and for all.
NYSE has tried for more than two years to end “broker voting,” where broker-dealers can vote the shares their investor clients own if those clients don’t provide specific voting instructions. Shareholder activists say it amounts to a free vote in favor of corporate management, since broker-dealers typically follow management’s recommendations when voting.
In February, NYSE revived a plan to end broker-voting by declaring all director elections “non-routine events,” which would forbid broker-dealers from voting in them. (Contested elections are already considered non-routine, and are off-limits to broker-voting. The new rule would apply to uncontested elections as well.)
The public comment period for the new broker-voting proposal ended March 27, and the Securities and Exchange Commission must approve the rule change for it to take effect. The SEC previously put broker-voting reform in the deep freeze, but many speculate that the Commission’s recent change in leadership heralds a more investor-friendly era favorable to a ban.
Still, the debate surrounding broker-voting has changed since the NYSE Proxy Working Group first proposed ending broker votes in June 2006. Since that time, throngs of companies have adopted majority thresholds for seating directors, and the SEC’s rules allowing online proxy statements have sent retail voting into the tank. All that (and more) has made a broker-voting ban much more complicated to implement.
In a March 17 letter, Trillium Asset Management’s senior social research analyst, Jonas Kron, described the current rule as “a serious impediment to shareholder democracy.” Likewise, the Council of Institutional Investors called the existing rule “out of date and unfair to shareowners,” and urged the SEC to accelerate the effective date so the ban would start as soon as the Commission approves it.
As currently written, the ban would apply to proxy voting for shareholder meetings starting next January. But if the SEC doesn’t approve it by Aug. 31, the effective date would be delayed at least four months and wouldn’t fall within the first six months of 2010. (The change would not apply to electing directors of mutual funds and other investment companies; they are exempt entirely.)
Critics’ chief complaint has been that a ban on broker-voting would raise the cost to solicit other votes, and in particular make it harder for small issuers to achieve a quorum—a point even acknowledged by the Proxy Working Group, which concluded that the greater cost is “a cost required to be paid for better corporate governance and transparency of the election process.”
A number of commenters, including the Society of Corporate Secretaries & Governance Professionals, the National Investor Relations Institute, Alcoa, and CSX Corp., argued that the change shouldn’t be made without other changes to the existing proxy system to remove communication barriers between companies and shareholders.
Morgan
“Any single change … without other changes to the proxy system may have unintended and devastating consequences,” NIRI president and CEO Jeffrey Morgan wrote.
Those unwanted consequences, Morgan said, include the potential for increased costs to public companies to achieve quorum, increased influence of proxy advisory firms, “additional power in the hands of the few shareholders who vote, and a magnification of the shareholder communications limitations associated with objecting beneficial owners.”
“Any single change … without other changes to the proxy system may have unintended and devastating consequences.”
—Jeffrey Morgan,
CEO,
NIRI
Alcoa and others also voiced the fear that for companies requiring directors to win a majority of votes cast, a ban on broker votes could result in more failed elections. John Endean, president of the American Business Conference, speculated that if the change is approved, “we might see tremendous resistance to adopting majority voting standards.”
Other Alternatives
Endean, who staunchly opposed the proposal because of the higher costs and quorum concerns, tells Compliance Week he likes it “even less” now because several large brokerages have adopted proportional voting as a way to split the difference.
Proportional voting is a system where brokers vote uninstructed retail shares in proportion to the voting instructions of other clients. Endean says that practice “better reflects the views of uninstructed shareholders.” Schwab, Ameritrade, Morgan Stanley, Merrill Lynch, and Goldman Sachs have all adopted proportional voting; as a result, Endean says, broker-voting is “a better instrument now than it was when NYSE floated its proposal.”
The current proposal is “anachronistic and irrelevant to corporate governance,” Endean says. “It doesn’t fit into the larger scheme of how corporate governance and the proxy system have evolved. It’s a bad idea whose time has passed.”
Instead, Endean plugs another idea: client-directed voting, where clients provide general preferences to brokers for how to vote their shares if they don’t vote. The practice was first proposed by Stephen Norman, corporate secretary for American Express, and Endean calls it “the next frontier for getting retail shareholders back in the game.”
CONSEQUENCES
Below is an excerpt of the discussion paper released by the SEC on the NYSE proposal to ban broker voting in director elections.
The Proxy Working Group report notes that this proposed change could significantly impact the director election process. For example, it is likely to increase the costs of uncontested elections, as issuers will have to spend more money and effort to reach shareholders who previously did not vote. These costs may increase substantially with the rise of majority voting for directors, as issuers have to obtain the votes from shareholders who may not realize that their failure to vote constitutes a “no” vote. Such a change may also increase the influence of special interest groups or others with a particular agenda to challenge an incumbent board, at the expense of smaller shareholders. These consequences could fall most dramatically on smaller issuers, who have a smaller proportion of institutional investors and/or have greater difficulty in contacting shareholders and convincing them to vote in uncontested elections.
Despite these potential difficulties, the Proxy Working Group stated in its report that it is important to recognize that the election of a director, even where the election is uncontested, is not a routine event in the life of a corporation. While this is likely to result in some greater costs and difficulties for issuers, it is a cost required to be paid for better corporate governance and transparency of the election process.
Following the issuance of the draft Proxy Working Group Report, in June 2006, the NYSE circulated the report to its listed companies and certain other entities and asked for comment on all of the proposed recommendations. The NYSE received approximately 46 comment letters or emails on the proposed recommendations; 39 of these letters related to amending Rule 452 to make the election of directors a non-routine matter. 15 of these comment letters strongly supported the proposed change to Rule 452, 8 letters expressed the view that the SEC should undertake an extensive review of shareholder communications before Rule 452 is amended, and 16 letters expressed concern regarding the proposed amendment. Among the primary concerns expressed with respect to the proposed amendment to Rule 452 was the potential difficulty in obtaining a quorum in uncontested elections without the use of the broker discretionary vote pursuant to existing Rule 452. This issue was raised by a number of operating companies, especially representatives of small and mid-size companies.
Securities and Exchange Commission (Feb. 26, 2009)
The Society of Corporate Secretaries and Governance Professionals touted proportional voting and client-directed voting as alternatives the SEC should consider to avoid disenfranchising retail shareholders and “an overall de-stabilization of the proxy voting system” if the Commission proceeds with the NYSE proposal. Other recommendations included changes to the e-proxy rules, regulation of proxy advisers, and investor education efforts.
A number of commenters cited a 2008 study conducted by Broadridge Financial Solutions and commissioned by CII, which analyzed shareowner voting and the effect broker-voting had on director elections at 1,297 NYSE-listed companies in 2007.
Broadridge found that more than 98 percent of all directors received a majority of votes cast in favor of their election, including 5,094 directors in companies with plurality elections. The elimination of broker votes would have prevented the election of only two directors out of a total of 7,812.
Callan
In other words, Broadridge Vice President Chuck Callan said, “Broker-voting isn’t tipping the scales; they’re already tipped by owners who are voting”—a phenomenon he dubs “ownership bias.”
But CII also noted that if broker votes were excluded in 2007, more than 600 directors would have seen at least 25 percent of their votes cast against them. Broker-voting, therefore, “obscures” otherwise clear indicators of shareholder displeasure.
Callan called proportional voting a “best-of-both-worlds scenario, because it more closely reflects actual returns and it doesn’t have the uncertainties that eliminating the broker vote does.”
The Broadridge study also showed that broker votes did result in more companies reaching quorum—and reaching it sooner—than would have been achieved without them.
Another concern is that the expected increase in the use of notice-and-access under the e-proxy rules (which allows a company to post proxy materials online, and then mail short notices to investors telling them where to find it) could further erode the retail vote. Broadridge statistics on first-year use of N&A showed that at the 653 companies that used it, the percentage of retail shares voted decreased from 34.3 percent to 16.6 percent on a year-over-year basis.
The statistics also show, however, that companies were less likely to use N&A if they had a non-routine management proposal on their agenda. Only 31 percent of N&A users had non-routine proposals on the agenda. That suggests that, if all director elections become non-routine, it might change companies’ decision to use notice-and-access.
No comments yet