Breaking the proxy voting circuit

In theory, it all seems so simple. An IR manager has a meeting with a portfolio manager and asks about the way he or she is likely to vote on a contentious resolution. The fund manager has a clear mandate on voting from his or her client and so can disclose that client’s voting intention. Job done. 

But there are many reasons why a vote cast in good faith by a fund manager might not be counted. The stock might, for example, be out on loan due to an arrangement between the custodian and the beneficial owner in a bid to reduce custodial fees. A lack of communication between these ‘back office’ operations and the ‘front office’ of the portfolio manager may mean stock is still out on loan during a close-run resolution. Unfortunately, the vote goes with the stock loan, meaning the fund manager’s word on voting intention is redundant (see box, below).
 

The stock loan issue is just the start. Bill MacKenzie, president of Toronto-based proxy voting agency Fairvest, notes the Canadian system came in for criticism in early July following the vote on a merger between Wheaton River Minerals and IAMGold. The merger had been dogged with controversy following hostile bids for both parties from US rivals. When the votes were counted there were some 26 mn votes over and above the eligible 145 mn outstanding shares. Some over-voting is normal in such situations due to changes in the shareholder base between the record date and the meeting date but an over-vote of this much – 18 percent – clearly implies a need for reform in the proxy voting system. 

In the US, which boasts the highest levels of proxy voting in the world, fears center on what might happen if the SEC’s proposal to include shareholder access to nominate directors on the proxy statement goes ahead. Many believe the proxy voting system as it stands would collapse under the strain. Indeed, over the last few months The Business Roundtable, an association of CEOs from major US corporations, and other commentators have been putting pressure on the SEC ‘to conduct a thorough review’ of the current shareholder communications system. 

Cumbersome & circuitous
The Business Roundtable submission to the SEC claims the current system of communications between shareholders and beneficial owners is ‘cumbersome, circuitous and expensive.’ It suggests the SEC take a detailed look at the issue, adding that the current system prevents companies from communicating directly with most of their Street name holders. ‘Instead, they must go through brokers and banks and their agents to distribute proxy materials to Street name holders and tabulate voting results,’ the submission continues. ‘As a result, it is very difficult and expensive for companies to communicate with their beneficial owners.’ 

It’s not just issuers’ organizations that are concerned, however. The argument is being backed by some people directly involved in the proxy process. John Wilcox, vice chairman of Georgeson Shareholder Communications in New York, falls into this group. He has actively petitioned the SEC on the need for reform in recent months, explaining that if the shareholder access proposal were adopted the system could not cope. 

‘The proxy voting system could be much better designed, more transparent and less expensive to run,’ says Wilcox. He points out that his company has a vested interest in maintaining the status quo because it can make money by exploiting the inefficiencies. ‘But rather than waiting until we have a crisis,
it’s essential to take a look at the system and modernize it – we need to take much more advantage of electronic technology.’ 

The call for more electronic voting and tabulation is a common refrain. The US is at a much higher level of implementation than most other markets on this issue but, according to Wilcox, there is still a lack of transparency, auditability and vote confirmation. He stresses the need for proxy voting reform is a separate issue to that of the SEC’s shareholder access proposal. ‘Some people have said this is nothing other than an effort to delay the shareholder access rule but that just isn’t the case,’ Wilcox insists. ‘We need to have a more efficient, less costly proxy system that has its own audit trail.’

Similar yet different

So what are the key issues here? First, there is a lack of direct communication between beneficial holders of stock – for instance, the trustees of a pension fund – and the companies in which they are invested. In many instances, firms don’t know who actually holds their stock or where voting control lies. They might know a certain portfolio manager is heavily invested on the part of several clients but getting beyond that to the beneficial holder can be more
trying. In the US, it can be impossible if the beneficial holder really wants to remain anonymous as an objecting beneficial owner (Obo) rather than a non-objecting beneficial owner (Nobo). 

Then there is the number of links in the chain between beneficial owners and the company in which they are invested, which might include portfolio managers, custodians, brokers, banks, nominee accounts, voting advisors and transfer agents – the list goes on. 

Communication between the front office management and the back office administration of the investment can be frustrated simply by one simple break in the chain. If one person does not log one piece of paper or click a mouse at the right point, thousands of votes can go missing. 

On top of this potential for leaks there is a range of technicalities that can frustrate the system if not dealt with correctly. Omnibus accounts are one such example: custodians often put their clients’ shareholdings into a single account under the name of one nominee company. That can make it difficult to separate them into the underlying beneficial owners when voting time comes around. Add to this stock lending and you have the potential for real confusion. Designated accounts for each beneficial owner allow for a much clearer audit trail but that raises the cost of custodial arrangements. 

Problems elsewhere

Despite criticisms of the US and Canadian markets, they are still more efficient than many of their peers. The US system, in particular, deserves its plaudits. It routinely gains the highest percentage of proxy votes cast of any market. Pension funds in the US have a fiduciary duty to vote their shares and most of them take it very seriously indeed. 

David Smith, president of the American Society of Corporate Secretaries (ASCS), notes that, by and large, the system works quite well. However, he points to the ‘monopolistic’ elements in the system as a potential area of concern. ‘ADP handles most of the voting for the Street side and I think it does a good job,’ Smith says. ‘Despite that, it’s always troubling when there is a monopoly.’ 

Smith acknowledges that ADP is used to such criticism and points out that it actually goes out of its way to show it is not abusing its position. ‘It does it very well under the current management but that could change,’ he adds. ‘The other side is the voting advisory services, which are pretty much dominated by Institutional Shareholder Services (ISS). It’s worrying that a company that is fairly unregulated can have such a dramatic impact on corporate behavior.’ 

Mike Kania, corporate compliance actions manager for Mellon Global Securities Services, points out that the US is a ‘record date’ market, whereby companies set a date prior to their meeting at which investors are entitled to vote their stock, and this helps iron out many of the problems seen in other markets. 

Stanley Dubiel, vice president at voting advisory service ISSProxy, agrees and notes that ISS is subject to competition in the US and Canada. ‘These markets probably do have the best voting systems,’ he says. ‘They are fully electronic, have the necessary processes in place and the record date system freezes the shares from 45 days to 60 days prior to the meeting.’ He believes the main issues lie outside of North America and many of them can be ironed out with a move toward electronic systems.