On July 14, 2010, the U.S. Securities and Exchange Commission (“SEC”) voted unanimously to issue a wide-ranging concept release seeking public comment on the U.S. proxy system.1 This is the first time the SEC has conducted a comprehensive review of the proxy voting infrastructure in nearly 30 years. The concept release was structured around three primary SEC concerns: 1) enhancing the accuracy, transparency and efficiency of the voting process; 2) improving shareholder communications and encouraging greater shareholder participation; and 3) the alignment of voting power with economic interest and investor disclosure on this issue.
The concept release has been characterized as “proxy plumbing,” perhaps to distinguish it from the more controversial reform to grant shareholder access to proxy statements, which is contained in the financial reform package recently signed into law. To be sure, the concept release does cover more technical aspects of the proxy process, including reconciling under- and over-voting of shares by brokers and other securities intermediaries (which arise primarily from ownership imbalances created by the securities settlement system), establishing a mechanism to allow shareholders and issuers to determine whether votes were properly cast, reforming the fees charged for the distribution of proxy materials and creating a clearinghouse of beneficial ownership data to facilitate competition for proxy distribution, and requiring proxy statement and voting information to be in an interactive data format.
However, the concept release also contains proposals that would significantly impact the voting process. For example, the SEC is seeking comments on permitting advance voting instructions to promote retail shareholder voting. Advance voting instructions would allow shareholders to instruct their broker how to vote their shares in advance of receiving any proxy materials on particular topics, such as director elections, auditor ratification or shareholder proposals. These instructions could be provided as early as when a shareholder opens a brokerage account. The availability of advance voting instructions would make it easier for an issuer to achieve a quorum, but may make it more difficult for a dissident shareholder to win retail shareholder votes in a proxy contest. As another example, the SEC is considering whether to allow beneficial owners to vote directly on an omnibus proxy and whether to eliminate the ability of beneficial owners to object to the disclosure of their identities. This would allow issuers, and presumably other proxy contestants, to communicate directly with beneficial owners.
Moreover, other proposals in the concept release may fundamentally impact the nature of the corporate vote. The SEC is concerned about “empty voting,” which occurs when a shareholder’s voting rights exceed his or her economic interest.2 This could occur in a variety of ways — the sale of shares after the meeting record date, borrowing shares immediately prior to the meeting record date or hedging share ownership (whether through put options, credit default swaps or purchasing securities in an issuer’s competitor or supplier) — so that a shareholder’s economic exposure to the shares is less than the number of shares the shareholder is entitled to vote. Proposals to address this issue range on a broad spectrum. On one end, the SEC has proposed advance disclosure of the shareholder meeting agenda to enable shareholders to recall any loaned securities prior to the record date. In the middle of the spectrum, the SEC has proposed requiring shareholders to certify they hold the full economic interest in the shares being voted or publicly disclose similar information. On the other end, the SEC asks whether voting should be limited to those who hold pure long positions (i.e., no hedged interests or short positions) or voting just the net-long position. Given the increasingly complex nature of hedging techniques, including multiple layers of hedging by counterparties, it would be difficult to determine what a net-long position would be and it may have the unintended consequence of creating an under-voting situation because the underlying shares cannot be attributed to any one shareholder.
Given the breadth of the SEC’s concerns and the far-ranging nature of the concept release, it is not surprising that some of the proposals may address one goal at the cost of another. For example, advance voting instructions would promote retail shareholder participation by making it easier to vote, but the vote would be uninformed because it would be done without the benefit of reviewing proxy materials and would likely be an automatic vote for management. Similarly, the SEC is also exploring allowing dual record dates (which was recently permitted in Delaware), with one record date for determining which shareholders would receive notice and proxy materials for a shareholder meeting and a later record date for determining which shareholders are entitled to vote. On the one hand, allowing issuers to establish a record date closer to the meeting date will increase the likelihood that shareholders are entitled to vote shares that they actually own. On the other hand, shareholders may not receive the proxy materials in time or at all to enable them to have an informed vote.
Although the promulgation of any new regulation flowing from the concept release would almost certainly not become effective until after the 2011 proxy season (and quite possibly not until after the 2012 proxy season given the new administrative and regulatory requirements resulting from the Dodd-Frank Wall Street Reform and Consumer Protection Act), the concept release does demonstrate the SEC’s continuing concerns regarding shareholder participation and transparency of the proxy voting process. Comments on the concept release are due 90 days following publication in the Federal Register.
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1 The concept release is available at http://www.sec.gov/rules/concept/2010/34-62495.pdf.
2 On a related note, the SEC also expressed its concern about the significant influence proxy advisory firms have on shareholder voting, particularly on institutional shareholders. Accordingly, the concept release suggests areas of regulation regarding proxy advisory firms, including registration under the Investment Advisers Act of 1940, disclosing conflicts of interests and promoting transparency of proxy advisory voting recommendations.
This article was originally published by Bingham McCutchen LLP.