On July 14, 2010, the SEC issued its concept release on the US proxy system, in which it raised numerous issues regarding the mechanics of US proxy voting and solicitation, dubbed “proxy plumbing.” The concept release sought public comment on these issues in anticipation of potential future rulemaking by the SEC in three main areas:
- Accuracy, transparency, and efficiency of the voting process, including over-voting and under-voting, confirmation of votes, proxy voting by institutional securities lenders, and proxy distribution fees
- Communications and shareholder participation, including company communications with shareholders, facilitating retail investor participation in shareholder voting, and data-tagging proxy-related materials
- Relationship between voting power and economic interest, including proxy advisory firms (such as ISS), dual record dates, and “empty voting” and related “decoupling” issues
While changes in regulations with respect to any of the above would have practical implications for public companies, the following items should stand out to directors and C-level executives due to their potential impact on corporate communications with shareholders and corporate governance.
Company Communications With Shareholders
The system of holding securities in “street name,” whereby a beneficial owner may elect not to disclose its identity to companies, has hindered the ability of companies to communicate with their shareholders. Companies may request brokers and banks to provide a list of beneficial owners who do not object to having their names and contact information given to the company. These “non-objecting beneficial owners,” or NOBOs, may be contacted directly by companies. Companies may not, however, communicate directly with “objecting beneficial owners,” or OBOs, who make up the majority of public company beneficial shareholders. The concept release floated a number of possible communication enhancements, including eliminating or modifying the OBO designation and the related NOBO/OBO election as a means to facilitate direct communication from companies to shareholders. Some of these enhancements, as well as other possible changes intended to increase shareholder participation in voting, might be particularly welcome to executives and directors in light of the movement to majority voting standards and the elimination of broker discretionary voting in uncontested elections.
Proxy Advisory Firms
The concept release raises several concerns regarding proxy advisory firms, including (1) conflicts of interest that may arise from proxy advisory firms providing proxy voting recommendations to institutional investors while also providing consulting services to corporations or sponsors of shareholder proposals on the same matters; and (2) that voting recommendations by proxy advisory firms may be made based on materially inaccurate or incomplete data, or that the analysis provided to an institutional client may be materially inaccurate or incomplete. The concept release proposes several possible remedies, including additional oversight of proxy advisory firms, improved disclosure about potential conflicts of interest of proxy advisory firms, and requiring proxy advisory firms to publicly disclose their voting recommendations in SEC filings.
Empty Voting and Related Decoupling Issues
Empty voting occurs when a shareholder's voting rights exceed the shareholder's economic interest in the company, which, according to the concept release, challenges “the foundational understanding that, absent contractual or legal provisions to the contrary, a ‘shareholder' possesses both voting rights and an economic interest in the company.”1 In some circumstances, an empty voter with a negative economic interest in a company may prefer that the company's share price fall rather than increase. This decoupling of voting rights and economic interest can be achieved, for example, by a shareholder buying a put option or using credit derivatives. The concept release questions whether such practices unduly influence voting results and whether the SEC should adopt rules requiring disclosure of decoupling activities or implement other possible remedies.
While the concept release discusses a number of potential regulatory changes that would impact the U.S. proxy system, no new or amended rules have been proposed, let alone adopted, in connection with the release. While some rules could be proposed and adopted relatively quickly, the overall reform of the proxy system will likely unfold over two or more years. Public companies and their officers and directors should continue to monitor the progress of such reform and, in some cases, may want to attempt to influence the resulting regulations.