SEC Roundtable on the Proxy Process
Securities and Exchange Commission (SEC)
Roundtable on the Proxy Process
Thursday November 15, 2018
Opening Remarks
SEC Chairman Jay Clayton and the Commissioners gave welcoming remarks and thanked the panelists and Division of Corporate Finance for the Roundtable, and Clayton explained that the focus of the Roundtable is to improve the system for long-term main street investors. Commissioner Kara Stein stated that the current proxy process is outdated and needs reforms to allow investors to participate in corporate governance, and queried how S. 3614, the Corporate Governance Fairness Act, would benefit investors. Commissioner Robert Jackson noted that he is looking to improve the way investors’ votes are counted and that discussing the role of proxy advisory firms is an important start. Commissioner Hester Peirce stressed the need to manage the conflicts between principals and agents, and Commissioner Elad Roisman added that he is looking for the discussion to provide examples and facts rather than generalizations and wants suggests for improvements.
Division of Corporate Finance Director William Hinman stated that he is looking for recommendations for market driven solutions but will consider regulatory changes if necessary. As discussed in the SEC’s 2010 Concept Release, Hinman discussed concerns in the voting process, particularly with over and under voting. Hinman is also looking for ways that innovation and technology, such as blockchain, can be utilized to address the problem. Hinman explained he is considering updating the rules for communication as companies can now communicate with shareholders instantaneously through a variety of means, including social media. He also requested that participants continue to submit comment letters after the Roundtable.
Panel One: Proxy Voting Mechanics and Technology
Overview of the SEC’s Advisory Committee Meeting
In response to David Fredrickson and Ted Yu of the Commission’s Division of Corporate Finance, Harvard Law School Professor John Coates gave an overview of the SEC’s Advisory Committee meeting on the proxy advisory process. In the meeting, the Committee agreed there is room for improvement and this is not the system that would have been created from scratch. The Committee agreed that some aspects will require regulatory changes but cautioned about regulatory burdens that prevent innovation. The Committee discussed the unique difficulties that exist for communicating with retail investors from institutional investors. As retail investor participation in voting is down, the Committee suggested potentially conducting a survey to find out why people do not vote. Some potential solutions to consider are creating a universal proxy, having Broadridge make their system easier, and reduce the layers of intermediation that may mismatch information.
Addressing Voting Numbers
Yu asked the panelists about the proxy and voting process and how to address over and under voting. Katie Sevcik of EQ discussed her experience from the DTCC and transfer agent sides and the frequency of over-voting, the lack of clarity when an over-vote exists and the difficulty in determining who should make the next step. Ken Bertsch of Council of Institutional Investors highlighted the fundamental problems and suggested rethinking the system. Bertsch stated that near-term steps include utilizing technology to provide routine and reliable vote confirmation, guidance on reconciliation for over-voting, and a universal proxy.
Voter Confirmation
Yu asked the panelists whether providing voter confirmation is possible today. Robert Schifellite of Broadridge stated that Broadridge offers a free service to determine whether there is an over-vote, but some tabulators have resisted participating in the confirmation process despite findings that a vote confirmation process helps resolve over-voting. Paul Conn of Computershare agreed that voting confirmation should be provided but stated there is no clarity on the confirmation’s content, and who is responsible for reporting. For example, whether voting confirmation means that it was received, counted, or came to the meeting. Conn also raised issues that contribute to over voting by lack of clarity for who gets to vote in situations involving share lending and borrowing to cover a short position. Sevcik stated that voter confirmation should provide the firms’ name and position and validate the DTCC position. Alex Lebow of A Say Inc. stated that brokers are great record keepers and can be utilized.
Experience with Proxy Voting
Yu asked Brian Schorr of Trian Fund Management to give an overview of his proxy voting experience with P&G. Schorr stated that the 2017 proxy contest with P&G was the closest to-date with a 0.25 percent voting margin. The preliminary results were issued five weeks after the meeting and resolved two months after the annual meeting. Schorr stated there was over voting that was not fully reconciled. Schorr also raised concerns with some financial institutions and shareholders not knowing that their shares were not included in the vote. For example, to neither party’s knowledge, one small fund administrator votes were excluded because of a name change in the custodian and a shareholder’s 50,000 shares were not included in the vote because the legal proxy and ballot were separated. Schorr also raised concerns with allowing unallocated shares in employee stock ownership plans being voted in favor of the current management. Schorr suggested sending proxy materials electronically, providing a universal proxy card, require intermediaries to facilitate voting, and moving to traceable shares.
Impediments to Beneficial Owners Voting
Fredrickson asked the panelists to discuss impediments to the beneficial owners voting. Bruce Goldfarb of Okapi Partners stated that there are complexities in the system that create difficulties for investors, particularly retail, to pick among the candidates when voting in a contested election. Darla Stuckey of Society of Corporate Governance suggested making the process electronic first and then potentially developing a universal proxy card after addressing how the proxy card will look. David Katz of Wachtell, stated that a universal proxy will help—after working through the details—but first the Commission needs to create a system that allows simple communications with the beneficial owner of the shares to improve voter turnout.
Non-Objecting Beneficial Owners and Objecting Beneficial Owners
Goldfarb additionally raised concerns with lack of voter turnouts and suggested amending the rules regarding non-objecting beneficial owners (NOBO). Several panelists stated that the NOBO-OBO system creates confusion for investors and many do not know the difference.
Clayton asked the panelists to explain the NOBO-OBO system and how to reach the shareholders. Goldfarb and Sevcik stated explained that OBOs are shareholders who have objected to the disclosure of their identities and share positions and NOBOs are non-objecting beneficial owners. Katz suggested moving away from the NOBO-OBO system and increasing shareholder engagement by providing no or low-cost communication. Goldfarb added that the Commission should eliminate the barriers to communication and any changes will need the weigh in from Division of Investment Management. Lawrence Conover of Fidelity Investments stated that the largest percentage of OBOs are institutional investors who want to continue protecting their privacy. Conn added that Companies cannot use the OBO lists for proxy distribution and suggested reforming the system while continue protecting investor privacy.
Economic Incentives of Intermediaries
Fredrickson asked the panelists to describe the economic incentives of intermediaries. Conover suggested creating incentives to ease the system for issuers and investors by allowing investors to receive materials in the format they desire, such as e-delivery. Katz added that economic incentives should focus on voters and not the intermediaries and suggested reviewing the system to allow direct electronic voting. John Zecca of Nasdaq stated that issuers do not have the ability to select the intermediaries and providing them with a choice may lead to more accountability. Lebow added that the incentives are counterintuitive because the entities choosing the party are not responsible for paying. Conn agreed that customers should have the right to choose how they want the information delivered and that allowing an intermediary to select the delivery and pass those costs to someone else is a flawed system.
Blockchain
Fredrickson then asked the panelists about the use of blockchain and how it can help the system. Bertsch stated that the Commission should first focus on what principles need protection and then develop a system where votes can be completed instantaneously. Bertsch added that a true distributed ledger may be best and moving to blockchain could result in long-term cost savings. Lebow explained the varying degrees of implementing blockchain and sees little advantage in solutions involving blockchain unless blockchain is moved forward in every area of the capital markets. Conn stated that he supports blockchain, but the Commission should not focus on the new technology until first identifying the problems and developing the principles. John Tuttle of NYSE added that the Commission should continue moving towards cost effective solutions.
Commissioner Roisman closed the panel by stating that after this discussion, he is concerned that today investors do not know if their vote was counted, not counted, over counted, or under counted. He continued that he wants to ensure that the basic tenants of voting is accomplished. Chairman Clayton agreed with the panelists on first outlining the goals and then using the technology available, stating that the goals are clearer and more timely communication while respecting the intermediary system for trading efficiencies.
Panel Two: Shareholder Proposals: Exploring Effective Shareholder Engagement
Direct Shareholder Engagement with Companies
The panelists discussed direct investor accessibility to voting as an alternative to proxy voting, particularly in light of available technology. Ray Cameron of Blackrock began by stating that shareholder proposals are important tools for shareholder review and balancing of rights. Danette Smith of UnitedHealth Group stated that an issue associated with shareholder proposals is that engagement with retail investors is more difficult than engagement with retail investors. Tom Quaadman of the U.S. Chamber of Commerce Center for Capital Markets Competitiveness urged the Commission to review ways by which voting can be more client-directed, such as through the use of social media. Ning Chu of Davis Polk specifically noted that Twitter could be used to raise awareness and get investors to vote. Quaadman emphasized the importance of management directors being in continuous communication with investors. James McRitchie, an experienced buy and hold retail investor, expressed concern about public access to information and urged the Commission to better use the education portion of its website to publicize and emphasize the role that shareholders play in a company. Smith added that the Commission should encourage brokers to develop easy platforms for voting. Smith lauded Fidelity’s website as an example of a simple and investor-friendly online voting platform.
Shareholder Involvement in Proxy Process
Panelists debated whether, and to what extent, shareholders should be involved with the development and submission of proposals associated with proxy votes made on their behalf. Several panelists agreed that shareholders, including retail investors, should have a certain level of knowledge and/or awareness of the proposal on which their vote is cast by proxy. McRitchie expressed a different opinion, arguing that individual shareholders should have the right to appoint agents to act in their stead without having to justify or explain the proposal or proxy vote. The panelists largely agreed that meaningful engagement with shareholders is critical to company operation.
Commission as a Facilitator of Meaningful Engagement Between Companies and Shareholders
The panelists discussed the utility, efficacy, and purpose of shareholder proposals. Quaadman began the discussion by noting the importance of the shareholder proposal process, but also noting that continued re-submission of previously unsuccessful proposals stagnates the proposal process. Several panelists agreed with Quaadman. Maria Ghazal of Business Roundtable suggested that the Commission help facilitate meaningful engagement by imposing proposal filing fees and enhancing oversight of proposal re-submission. The panelists discussed the potential effects of establishing an ownership threshold, which shareholders must meet in order to submit proposals. Brandon Rees, Deputy Director of Corporations and Capital Markets for labor unions, emphasized that shareholder proposal rules serve an important democratic purpose to allow small investors to bring forth issues. Rees later noted that if the SEC were to implement a high threshold, retail investors would have less voting power.
Panelists also discussed proposals that are purely social or political in nature. Several panelists noted that despite the fact that such proposals are not directly related to a company’s profitability, they may be useful in developing future strategies to increase long-term company value. McRitchie noted that social, political, or environmental goals of a submission are often achieved regardless of whether they are accepted as proxy proposals.
Panel Three: Proxy Advisory Firms: The Current and Future Landscape
Why Proxy Advisory Firms are Used
The panel began with a discussion of the role of proxy advisory firms. Rakhi Kumar of State Street Global Advisors stated that firms use proxy advisory firms to obtain research, ease internal operations, and facilitate company decision-making. Jonathan Bailey of Berman noted that the use of proxy advisory firms helps with workflow management and allows for useful and aggregation and standardization of data. Scott Draeger of R.M. Davis Private Wealth Management highlighted the important role that proxy advisory firms play for smaller companies that otherwise do not have the resources to have an internal research department perform the type of proxy research provided by the firms. Former Senator Phil Gramm (R-Texas) emphasized that proxy advisors and index funds always have fiduciary responsibilities and noted that there is a risk that index funds may use proxy votes for self-publicization. Panelists also agreed that proxy advisors are especially useful and cost-saving in situations where a vote is not contentious and would otherwise be a waste of time for the company to review.
How Investment Managers Use Proxy Recommendations
Gary Retelny of Institutional Shareholder Services Inc., a proxy advisory firm, addressed the usage of the term “robo-voting,” which suggests that investment managers automatically vote in line with a proxy recommendation. Retelny emphasized that proxy firms help investors vote according to their own custom policies based on data. Katherine Rabin of Glass, Lewis & Co, a proxy advisory firm, further emphasized that the primary job of a proxy advisor is to execute votes in accordance with a client’s specific instructions. Rabin stated that at least 80 percent of voting is done in a customized manner, rather than automatically in alignment with the proxy recommendation. Draeger agreed, stating that the term “robo-advising” is a “red herring” that does not reflect actual practice.
Addressing Potential Conflicts of Interest
The panelists discussed how they manage and mitigate any conflicts of interest that may arise in connection with a proxy advisory firm’s services. Retelny acknowledged that there are potential conflicts of interest because his firm is a registered investment advisor. He stated that there is no communication between the proxy and corporate sides of the business, and that his firm provides enhanced transparency by allowing corporate clients to view who all the corporate clients are, how much they pay the firm, and what they purchase. Rabin stated that her firm has always disclosed all conflicts on the front page of the report. Draeger noted that the current disclosure regimes are sufficient, but that a different issue is whether a conflict that is not disclosed exists. Several panelists discussed the use of proxy recommendations for index funds. Gramm expressed concern that index funds would be exempt from their fiduciary duty if they follow the recommendation of proxy firms and urged the Commission to recognize this fiduciary duty.
Addressing Errors in Reports
All panelists agreed that proxy firms must immediately make known any errors in their data or reports. Retelny noted that it is important to distinguish between errors of fact and differences in opinion. Rabin noted that it is possible for a report to make a favorable recommendation based on an improper basis according to the client’s policies.
Potential Regulatory Changes
Panelists agreed that additional regulation is not necessary. Sean Egan of Egan-Jones Proxy Services, a proxy advisory firm, stated that sufficient regulation already exists. Bailey noted that additional regulation could actually adversely impact the timeliness and quality of the research and recommendations that proxy advisory firms provide. The only call for action made to the Commission was Gramm’s request that the Commission make clear that proxy advisory firms have a fiduciary duty and take away any safe harbors exempting firms from fiduciary duty.
For more information on this roundtable, click here.