Who Speaks for the Silent Investor Majority?

The U.S. investor population is booming: more than 90 million individuals invested directly or indirectly in our securities market, according to most reliable estimates. Yet, as the Securities and Exchange Commission and self-regulatory organizations engage in rule making that affects individual investors, what organization truly represents their interests?

Maybe nobody does, at least effectively.

The mutual funds, pension funds, brokerage firms, financial analysts, and professional investors all have trade associations able to lobby the regulators and the Congress on behalf of their special interests. They can exert powerful influence over the regulators. But when you scour the landscape for an association that speaks for the combined interests of individual investors, there is none. Moreover, it’s unlikely there will be one, since most people are passive investors unlikely to pay dues to belong to an organization that would represent them. Instead, they basically trust the managers of their funds to act in their best interests.

Still, those who invest through brokerage accounts tend to be more active. A survey conducted by the Opinion Research Corp. in 2006 for the New York Stock Exchange found that 63 percent of such investors said they open all of their proxy statements and read at least some of them; 43 percent said they always vote their proxies. Those findings should emphasize to companies how important it is for them to reach out directly to their “street name” investors, particularly during the proxy season. As the Baby Boomers move toward retirement, they could well be more active as investors, since many have demonstrated activism in other areas of their lives.

Two individual investor associations that largely provide educational information to their members (rather than serving as a voice for individual investors in the regulatory or lawmaking processes) are out there. The American Association of Individual Investors is a nonprofit organization with 150,000 members. The National Association of Investors Corporation (NAIC), also a nonprofit, has approximately 120,000 individual members, who are part of some 13,000 investment clubs around the nation—although, that membership is down from its peak of 400,000 in 1999.

The NYSE Euronext has an Individual Investor Advisory Committee (of which I am a member) that provides input into the self-regulatory process focused on the needs of individual investors. The committee also recommends investor education programs to the exchange.

One bright light for individual shareholders who hold their stock through brokerage firms is that the NYSE is expected to require its member brokerage firms to survey their investors before the 2008 proxy season, to see whether they want to receive direct communications related to proxy issues from the companies in which they invest. The Opinion Research survey indicated that 73 percent wanted their contact information provided to companies so they could receive direct communications.

One of the more insidious new practices in proxy voting is called “empty voting.” It works like this: Investment funds (usually activist hedge funds) pay a fee to borrow the voting rights to shares held by pension funds or brokerage firms prior to a company’s record date; that boosts the funds’ voting power in director elections and other proxy issues, even though they have no economic interest in these borrowed shares.

What’s troubling here is that when brokerage firms loan the voting rights for shares held by their individual account holders, no disclosure of that is required, and so these investors don’t know they have lost their voting rights.

If double voting does occur, it is not discovered until the votes are reconciled after the proxy vote is completed. To get a sense of the magnitude of this issue: It has been reported that in the 2007 proxy season, the California Public Employee Retirement System earned $142 million from loaning the voting rights to shares held by the giant pension fund.

On the corporate side, companies largely held by institutional investors devote scant resources to serve the needs of their individual investors. For example, a company 80 percent owned by institutions and with only one or two investor relations officers is going to focus its attention on the needs of its major investors. In setting priorities, IROs have little time to respond to questions from individuals who hold only a few shares. Instead, they increasingly rely on the company’s Web site to provide information that individuals might need: news releases, frequently asked questions and answers, annual reports, and background information on the company.

So, back to my original question: Who really represents the interests of the individual investor?

Of course, investor protection is an important function of the Securities and Exchange Commission. The passage of Regulation Fair Disclosure seven years ago was an effort to level the playing field among the financial analysts and institutional and individual investors by providing equal access to material information. Individuals can listen to companies’ quarterly conference calls on a real-time basis, although relatively few do so. And, the SEC’s enforcement efforts also help to protect individual investors. The SEC is expanding its investor education program with the recent appointment of Kristi Kaepplein as director of investor education and advocacy. The “advocacy” part of her title is a much-needed addition to the job.

Who on the non-regulatory side represents individuals? It’s the professional investors and those who vote the proxies in the various funds.

But who on the non-regulatory side represents individuals? In reality, it’s the professional investors and those who vote the proxies in the various funds who are primarily responsible as custodians of the individual investors’ plans or accounts. The investment managers are, of course, focused on creating greater value for their investors. But they are normally not the ones who vote the proxies. And hopefully, those charged with proxy voting are not accepting recommendations carte blanche from the proxy advisory firms like Institutional Shareholder Services; they should also consider whether those recommendations are in the best interests of the investors or plan participants.

The Chartered Financial Analysts (CFA) Institute, whose members are professional investors, maintains a code of ethics and standards for professional conduct intended to protect the interests of all investors. Ironically, the Securities Industry Association, representing the brokerage firms, strongly opposed Regulation FD at the time it was proposed, even though the measure was designed to provide equal access for all investors to material corporate information.

What can be done to ensure the individual investor is fairly represented?

In 1987, the tide turned from a market dominated by individual shareholders to one led by institutional investors. Therefore, the latter should act on behalf of the millions of shareholder clients who have no real voice and rely on the institutions’ good judgment to properly manage their funds.

The SEC, when it calls for plain English in the various disclosure means, needs to “walk the talk.” Complex regulations and highly detailed SEC staff comment letters to companies regarding their disclosures do not foster the use of plain English for better investor understanding.

The SEC should stop the practice of empty voting or, at a minimum, require full disclosure on the part of those loaning the voting rights. They should identify the borrowers and the number of share voting rights that have been loaned and inform the individuals who have lost their voting rights.

Corporations should take advantage of opportunities to communicate directly with their individual investors on proxy issues, given that the individuals could provide the “swing vote” on closely contested issues. And, with the increase in “say-on-pay” proposals to oversee executive compensation, as well as majority voting for directors, individual investors could become more active in their proxy voting. Meanwhile, in advance of the proxy season it is vitally important for company representatives to meet with the institutional investors who vote the proxies to explain the company’s position on the issues.

While institutional investors are the dominant decision makers in our securities markets, in reality they represent the millions of relatively voiceless individuals when making investment and proxy voting decisions. Likewise, corporations should continue to find ways to better communicate with their individual shareholders while continuing to serve the informational needs of the institutions that are the individuals’ de facto representatives.