Empty Voting in the Spotlight
Hedge funds, activist investors, issuers and corporate governance advisors will be paying close attention to the practice of "empty voting" after the decision of the British Columbia Court of Appeal (the "BCCA") regarding the proxy battle between Telus Corp. ("Telus") and the U.S. hedge fund Mason Capital Management LLC ("Mason") which shone a spotlight on the issue. The BCCA found that empty voting did not violate any laws nor did the court find any legal basis upon which it could intervene on the issue. As a result, the Telus decision appears to signal a green light for the continuation of empty voting, at least until a regulatory response is implemented.
What is Empty Voting?
Empty voting is the term used to describe a number of circumstances that, whether intentionally or not, decouple the economic interest in a share from the voting rights attached to it.
Empty voting can occur in various ways, including when an investor sells shares between the record date and the meeting date so that she no longer has an economic interest in the outcome of the shareholder vote but retains the ability to affect the outcome of the meeting. The chairman of the Canadian Society of Corporate Secretaries (as quoted in the August 2012 edition of Corporate Secretary magazine) has indicated that a five year plan is being developed with a view to rectifying certain Canadian proxy plumbing issues, including reducing the number of days required by statute between record dates and meeting dates. If implemented, this plan would reduce instances of empty voting arising due to the sale of shares between the record and meeting dates. Empty voting can also result when, prior to the record date of a meeting, an investor borrows shares, thereby acquiring the voting rights attached to such borrowed shares. The type of empty voting that triggers the most policy concerns arises when an investor employs hedging techniques that insulate against the economic risk of holding shares or that result in the investor having a large voting interest with a relatively small economic interest. Mason's holdings in Telus gave rise to this latter type of empty voting.
Corporate law is premised on voting rights being proportionate to an investor's economic interest in the shares being voted. Empty voting, especially empty voting that is intentionally employed to affect the outcome of a proxy battle, causes concern because of the misalignment created between voting rights and the investor's economic interest.
Currently, there is no restriction on the practice of empty voting and the BCCA's decision in Telus signals that the practice can continue, at least while the capital markets await a regulatory response to the issue.
Brief Background to the Empty Voting issue in Telus
Telus has voting and non-voting common shares and is seeking to collapse its dual-class structure. In the past, Telus' common shares had traded at a premium to the non-voting shares. Mason had acquired Telus common shares and shorted Telus non-voting shares. As a consequence, Mason opposed the plan by Telus to eliminate the non-voting shares on a 1:1 basis in exchange for common shares and felt that the exchange ratio should reflect the historic premium to the market price of the voting shares. Mason requisitioned a meeting of Telus' shareholders so that it could put forward resolutions requiring the share consolidation to take place at an exchange ratio of voting to non-voting shares reflecting the historic premium on the voting shares. Telus objected to the validity of Mason's meeting requisition based on a number of factors and, in connection with this objection, alleged that Mason was practicing empty voting because Mason's control over Telus' voting shares was "many times" Mason's net economic interest in Telus.
The BCCA on Empty Voting
The BCCA found Mason's meeting requisition to be valid and, along with examining other factors in reaching this conclusion, considered the challenge to shareholder democracy created by empty voting.
The BCCA found that empty voting poses a concern and that Mason's limited economic interest in Telus put it in a position where the value of Telus' shares was of limited concern to Mason. The BCCA found that Mason's interests lay in widening the gap between the prices of the non-voting and common shares . However, since the BCCA found that Mason was not violating any laws and since the court could not find any statutory provision allowing it to intervene on the grounds of equity, the BCCA stated, "to the extent that cases of "empty voting" are subverting the goals of shareholder democracy, the remedy must lie in legislative and regulatory change."
The Path Forward: Dealing with Empty Voting as a Modern Reality
A chief executive of Telus was quoted in the press saying that Telus will push for regulatory change to prevent the legal strategy of empty voting.
Prior to the Telus decision, issues relating to empty voting had been tabled for discussion by the Securities and Exchange Commission (the "SEC") in the U.S., the Canadian Securities Administrators (the "CSA") and the Ontario Securities Commission (the "OSC"). Starting in 2008, the CSA issued a request for comment on proposed National Instrument 55-104 – Insider Reporting Requirements and Exemptions. The CSA responded to the public's comments on the subject of "hidden ownership and empty voting" by saying that the submissions it received were being considered alongside reform proposals in other jurisdictions. In 2010, the SEC released proposals for public comment on "proxy plumbing" issues and, closer to home, in its Statement of Priorities for fiscal 2012-2013, the OSC has flagged the question of how to improve the proxy voting system (without any explicit reference to empty voting). What action and legislative changes, if any, will result from these public consultations remains to be seen.
It may be that a regulatory response to empty voting has yet to be implemented due to the complexity of the issue and because empty voting only becomes apparent and of concern when the tactic is used by an investor with a significant voting interest trying to challenge an issuer's management. It is possible that a prohibition on at least certain types of empty voting may be implemented, alongside a regime that requires investors to disclose their long and short positions in an issuer when those holdings exceed a certain minimum threshold.
In the meantime, issuers, investors and their advisors will be watching for developments on this issue, if and when they arise and it is likely that activist investors will govern their proxy battle strategies accordingly.