Can the system be fixed if nobody knows exactly what's wrong with it?
As the old saying goes, ‘If it ain’t broke, don’t fix it.’ But what happens when something is broken and no one knows how to fix it – because no one knows exactly what is wrong? That’s the current situation with communication between listed companies and their shareholders, and more specifically with the system for proxy voting.
Regulators in both the US and Canada have been searching for a way to overhaul the system in order to improve the flow of information and the rights of both companies and owners, without unduly damaging efficient operation of the markets. Canada has been taking its time – and rightly so – and has been able to learn much from the US experience, but there are some unique elements that make direct comparison difficult.
Regulatory group the Canadian Securities Administrators (CSA) currently has a list of proposals addressing the issue. These amendments are open for public comment until the end of August, so if you have anything to say and have not already done so, you’d better do it quickly.
The proposed new rules will impact the process for dealing with beneficial owners. Among other things, the proposal contains a first pass at a notice-and-access rule similar to that seen in the US.
What the CSA is proposing right now, explains David Masse, assistant corporate secretary at CGI Group, ‘is a kind of weaker potion for the Canadian market where the issuer would be able to carry out notice and access if it wished to, but only for normal course meetings, not for meetings where a special resolution is proposed to be adopted. This is not that much of a restriction, because the definition of a special meeting is not just one where there is special business but also one where a two-thirds resolution needs to be adopted. So that’s a relatively narrow class of exempt meetings.’
Notice and access is interesting, Masse says, ‘primarily because it eliminates, or has the potential to eliminate, most of the paper mailing that happens.’
Off the paper trail
Carol Hansell, senior partner at Davis Ward Phillips & Vineberg, doesn’t think there’s any doubt that some problems will be solved or addressed, at least in part, by eliminating paper. ‘A lot of the problems we have in the proxy voting system are due to a reliance on a paper-based process that is unwieldy and inefficient,’ she says. ‘It is still the case that some investors are not ready for the electronic system – they lack the equipment or the expertise, or it’s just not something they’re comfortable with.That will become less and less the case in the future, so we have to move to a system where we are not dependent on paper going back and forth. This is a good first step; it’s thoughtfully laid out, and I think it will probably generate a lot of very helpful comments.’
‘It is a bit of a double-edged sword,’ says Masse. ‘While shareholders may receive multiple envelopes, they are not going to be receiving annual reports and proxy circulars, which I think is what most people were complaining about. The problem, however, is that electronic voting tends to further decrease participation by beneficial shareholders, which was already quite low. This is something that I think has been clearly demonstrated by the US experience with the system.’
As in the US, it is likely that companies will conduct reviews of the shareholder base to determine the role retail ownership plays in the overall voting picture. If it is minimal, the adoption of notice and access will be far easier. Otherwise, it may be worthwhile taking a stratified approach where some shareholders get hard copy and others get online access. Details of the final rules will doubtless change in the coming months.
Secret identities
There are other, perhaps more
important, problems with the system. One area that attracts considerable debate is the objecting beneficial owner/non-objecting beneficial owner
distinction, which prevents companies from identifying most shareholders – and thus from
communicating with them. It is very difficult at any given point in time to know who your beneficial
shareholders are because of liquidity in the marketplace, and the system is structured in such a way as to allow positions to change hands very quickly.
‘With very low participation by beneficial owners,’ explains Masse, ‘there is the potential for mischief, where shares can be voted multiple times. This is because the intermediaries and market participants who have large positions have a tendency to lend securities for the purposes of short selling, and they make some money by doing so; this reduces their portfolio costs, but it also allows those shares to be borrowed and then sold and potentially re-borrowed and resold, with the result that there may be quite a large number of potential claimants to the voting rights for any particular share. And there is no easy way to observe how prevalent that result is, simply because the beneficial shareholders don’t vote anyway.
‘Even if you have an over-voting ratio of 300 percent because turnout is so low, that still might only be equivalent to a 30 percent turnout of beneficial holders,’ Masse continues. ‘That is an important systemic problem that needs to be addressed. What I am sure of is that the system is currently so complex that there is no single industry participant that has a really good global view of the problem.’
Hansell agrees. ‘One of the main issues is that people don’t really understand how the system works or where the problems lie,’ she says. ‘The people who understand it are the people who are intimately involved, like the transfer agents or Broadridge, but it’s only relevant to them from a specific business perspective.
‘Personally I think it is highly unlikely that we are going to eliminate confidentiality. That would be unpalatable to institutional investors, who find it a convenient way to fly underneath the radar of issuers. It would be unpalatable for retail investors, who do not want to be called at home and pestered to vote. We’re not really contemplating changing the system in Canada at this time.’
Reducing the complexity of the process is a serious challenge, and both Masse and Hansell agree that a regulatory approach may not necessarily be the answer. ‘There are a lot of aspects of the shareholder voting system that the regulators don’t have anything to do with,’ Hansell explains. ‘So many people who are familiar with the process for shareholder voting will agree that the system is broken. The regulators don’t even purport to regulate the whole thing.’
‘Part of the problem is that the regulatory environment only recognizes the registered owner on the corporate law side and does nothing to recognize the other structure,’ Masse says. ‘So I think the first step is to adapt corporate law to the 21st century, to recognize the role played by proxy agents and to understand the way the market actually works.
‘It is a corporate law solution – not a securities law solution,’ Masse contends. ‘And right now the only people focusing on this issue at the regulatory level are doing so from the securities law side; apparently they don’t even work in the same building as the corporate law regulators.’
