Breaking the broker vote

In response to the heated debate generated by the NYSE’s proposal to eliminate broker voting for uncontested director elections, the SEC held a roundtable on proxy voting mechanics on May 24. A panel on broker proxy voting under NYSE Rule 452, moderated by Erik Sirri of the SEC’s Division of Market Regulation, included: David Berger, partner, Wilson Sonsini Goodrich & Rosati; John Endean, president, American Business Conference; Anthony Horan, corporate secretary, JP Morgan Chase; Catherine Kinney, president, NYSE Euronext; Donald Kittell, CFO, Securities Industry and Financial Markets Association; and Paul Schott Stevens, Investment Company Institute.

Because the new rules center on director election votes, the SEC agenda suggested that the panel look at the impact of broker voting on director elections, whether a disproportionate burden would be placed on some issuers such as investment companies and small issuers, strengths and weaknesses of proportional voting and how the proportional voting experiment was working in the 2007 proxy season. An informal transcript and webcast archive are available at the SEC website.

Anything but routine

NYSE Rule 452 entitles brokers to vote on some ‘routine’ issues if the beneficial owner has not provided specific voting instructions ten days before a scheduled meeting. As so many beneficial owners don’t vote their positions, broker voting of uninstructed shares helps issuers (especially smaller issuers) meet quorum requirements to conduct business at shareholder meetings.

The NYSE currently lists 18 non-routine items. In the past few years, the exchange has had to take increasingly controversial positions on what is a ‘contest’ situation, where a broker vote is not permitted. ‘Withhold campaigns’ and ‘just vote no’ situations with no opposing director slated are deemed routine matters, which has caused complaints by some investor and institutional groups. 

Because of the increasing need to take on this interpretive role, and recent developments regarding proxy voting and shareholder activism, the NYSE convened a proxy working group to review and make recommendations on proxy voting rules. Formed in April 2005, in June 2006 it recommended the NYSE consider non-contested director elections to be non-routine and eliminate broker voting. The NYSE filed the proposal in October 2006, with an effective date for shareholder meetings held on or after January 1, 2008. 

While the working group understands their recommendation will add time and cost as issuers solicit the votes of holders who do not routinely vote on these types of issues, it also views director elections as central to a company and as such, not routine even in non-contested director elections. Under the current system, 75 percent of shares are held by OBOs (Objecting Beneficial Owners, who object to direct contact from issuers). Many investors do not understand the OBO/NOBO distinction, and intermediaries often guide new accounts to OBO status without explaining the situation. Kinney advocated for greater investor education on this point during her comments, suggesting the issue be made plain when beneficial owners sign brokerage agreements. Doing so could cause more investors to adopt NOBO status and help issuers with investor access, reducing solicitation costs.

Paul Schott Stevens asks that mutual and closed-end funds be excluded from the proposed rule. With mostly retail holders, these funds will have a hard time reaching state law quorum without broker votes. He also pointed out that as highly regulated entities, mutual funds are different from operating companies. They generally do not have any other uncontested issues on the ballot that could assist getting out the vote to achieve quorum. He warned solicitation costs for mutual funds would double if they were not exempted.

An alternative system is proportional voting, under which brokers vote uninstructed shares in the same proportion as instructed shares. The Securities Industry and Financial Markets Association encourages members to use proportional voting for the 2007 proxy season, and to vote uninstructed shares in proportion to voting instructions received by each broker from their retail clients. The group believes this is more appropriate than blanket votes for management. The SEC’s agenda proposed to assess how this was working, but no discussion of the 2007 season or cost took place. 

Tabulating proportional voting can be handled in several ways: Vote uninstructed shares in proportion to: all shares cast; only beneficial owners who provide instructions; retail beneficial owners who provide intermediaries instructions. Alternatively, proportional voting could be tied to voting by individual brokers (broker-by-broker) or to aggregate voting by all brokers.

Disproportionate influence

But broker-by-broker voting raises concerns that, while easier to implement than aggregate voting, it would skew results to a broker’s client base. Proportional voting does, in fact, continue to assign votes to uninstructed share positions. It would also heighten the influence of shareholders who vote since their vote would be proportionally assigned to uninstructed positions.

Client-directed voting has also been proposed. Beneficial holders would make general voting decisions when they sign initial brokerage agreements. But this option raises concerns that a shareholder is making an uninformed vote before receiving proxy materials. Client-directed voting is the least understood of the options. Proposed by Stephen Norman, corporate secretary at American Express, this option is reportedly favored by SEC commissioner Paul Atkins.

The lesser of three evils?

Under Norman’s proposal, a shareholder would have five choices when entrusting brokers how to vote: (a) vote as management recommends; (b) vote against management; (c) abstain on all matters; (d) vote in accordance with the brokerage firm’s published voting policies; (e) vote proportionally with the firm’s other clients’ instructed votes on the same issue.

However, it might be educational to have further discussions on this topic. Only someone who strictly adheres to the Wall Street Rule (if you don’t like how the company is governed, sell) would choose option a. Option b is for wealthy radicals who think all businesses are bad but can’t find anywhere else to invest. Option c says: ‘I’m not voting but count me as having voted anyway.’ The last two options are a little more interesting and could lead investors to include governance reputation as a factor in choosing a broker.

The SEC’s 2003 rules requiring mutual funds and investment advisors to disclose votes and voting policies inspired some excellent research on mutual fund voting. Where is there similar analysis for investment advisors?

Serious discussion of client-directed voting could spur development of additional options. On his My ProxyAdvisor website, Andy Eggers, founder of Proxy Democracy, offers voting advice: ‘Before each voting deadline, we find out how respected institutional investors with a variety of voting philosophies have chosen to vote their shares. We’ll help you figure out which funds have similar voting philosophies to yours. When a fund you agree with makes a decision on a stock you own, we’ll send you a free alert. You’ll have a week or two to look at their decisions and cast your own ballot.’

The next step in Eggers’ system would be to facilitate the retail shareowner’s ability to transfer their voting rights to a fund with ‘similar voting philosophies.’ A step further in usability, if not development, would be a more comprehensive ‘proxy exchange’ allowing shareowners to easily transfer voting rights among themselves or to trusted institutions (for more information see Glyn Holton’s paper, Investor Suffrage Movement).

Investing in time

Elimination of broker voting takes 60 to 70 percent of retail shareowners out of the picture, but it doesn’t address the more fundamental issues. How can we get shareowners to think of themselves as long-term owners rather than as bettors? What tools can make voting  not only easier but also more intelligent?

Norman’s client-directed voting, which facilitates retail shareholders’ ability to transfer voting rights, and Holton’s proxy exchange both allow lazy shareowners to make slightly more intelligent decisions based on reputation. Though Norman’s idea currently does not offer enough choices to get there.

The system being developed by Eggers, which enables owners to learn how others are voting, will still require a fairly conscientious shareowner because they will need to vote each individual holding. This may not appeal to the lazy shareowner, but it could lead to further differentiation of choices through reputational development.

Another option is shareowners collectively hire entities to research and advise on issues. While educating shareowners, it would further the research. Institutional investors and wealthy individuals can already avail themselves of services of investment advisors and proxy monitoring firms.    

However, as Mark Latham of the Corporate Monitoring Project notes, Institutional Shareholder Services’ (ISS) team of 20 analysts make recommendations for 10,000 US companies. He estimates they devote four hours of analysis per proxy, costing perhaps $2,000. ‘Considering the amount of money we shareowners pay CEOs and boards of directors who are elected and compensated based on our voting, and the amount of capital at stake in the typical company they manage for us, we should be spending more than $2,000 to guide our voting,’ says Latham. Still, better-informed shareowners are more likely to become long-term investors.

Something significant lurks in the detail of proxy voting mechanics, and good or bad, it’s causing a stir among companies. Perhaps further discussion prompted by the SEC’s roundtable will move beyond proxy mechanics and encompass these larger issues.