Proxy-Voting May Not Be Soley For The Economic Benefit of Retirement Plans

Earlier this month, the U.S. Chamber of Commerce submitted an additional comment letter to the SEC's proxy plumbing concept release. Among other things, the Chamber recommended that the SEC take steps to insure that the advice given by proxy advisory firms to retirement plans adhere to appropriate ERISA requirements. This suggestion was based on a report prepared by the Office of the Inspector General of the U.S. Department of Labor (attached to the comment letter). The OIG conducted an audit of the Employee Benefits Administration (EBSA) and had several findings and recommendations, which the OIG summarized as follows:

"WHAT OIG FOUND

EBSA does not have adequate assurances that fiduciaries or third parties voted proxies solely for the economic benefit of plans. EBSA’s proxy-voting requirements do not specifically require fiduciaries or investment managers to document (1) the monitoring of proxy-voting activities or (2) economic rationale for proxy-voting decisions. For the calendar year 2009, we found that fiduciaries did not document that they monitored proxy-voting decisions for 90 percent of plans we reviewed, and proxy voters were unable to provide documentation to substantiate the economic benefit of proxy-voting decisions for 2,455 of 3,194 (77 percent) proposals, representing votes on 574 million shares of stock with values totaling $11.6 billion.

We also noted EBSA has devoted few resources to enforcing proxy-voting requirements. While EBSA did conduct three proxy-voting projects between 1988 and 1996, EBSA did not routinely review proxy-voting decisions. EBSA lacks the statutory authority to assess penalties in cases that did not result in financial losses to plans and it is difficult to attribute monetary losses to proxy-voting decisions. EBSA also stated court cases have shown that fiduciaries may not need to document the rationale for their fiduciary decisions.

Without additional transparency and enhanced enforcement activities, concerns about the fiduciary use of plan assets to support or pursue proxy proposals for personal, social, legislative, regulatory, or public policy agendas, which have no clear connection to increasing the value of investments used for the payment of benefits or plan administrative expenses, may not be properly addressed.

WHAT OIG RECOMMENDED

We made three recommendations to the Assistant Secretary for the Employee Benefits Security: (1) propose amending ERISA to give the Secretary of Labor the authority to assess monetary penalties against fiduciaries for failure to comply with proxy-voting requirements, (2) revise proxy-voting requirements in 29 CFR 2509.08-2 to require documented support for fiduciary monitoring and the economic benefit for proxy-voting decisions, and (3) include fiduciary proxy-vote monitoring in enforcement investigations to ensure that the economic benefit for proxy-voting decisions are appropriately documented.

The Assistant Secretary for Employee Benefits Security did not agree to implement our recommendations. While EBSA supported expanding ERISA civil penalties for all fiduciary breaches, it did not believe proxy-voting activities warranted specific legislative changes, specific documentation requirements, or increased enforcement activities."

DTC claims factual inaccuracies, Society distances itself from Shareholder Communications Coalition, Plagiarism in Comment Letters, plus more

In my last post I wrote that that a few more comments had dribbled in past the October 20 deadline.  Well, it's now up to 30 more letters (although a few of these are of the "form" variety). Some of the new batch are quite thoughtful and provide concrete examples. In this regard, the October 22 letter by UnitedHealth Group is worth a read.

Some letters wanted to set the record straight.  The October 25 letter of the Depository Trust & Clearing Corporation, whose subsidiary is the The Depository Trust Company (DTC), writes that it "takes issue with any characterization in the [SEC Concept] Release that casts doubt on the legitimacy of the [DTC Omnibus Proxy] Procedure.  The Release cites, on page 18, footnote 42, the decision of a Delaware Chancery Court subsequently overturned. The court makes a statement about a lack of standard policies or procedures governing DTC's production of omnibus proxies, which is not well-founded and is factually inaccurate. . . .  DTC has a longstanding and public Procedure pursuant to which it issues the omnibus proxy as soon as possible following record date. This Procedure is effective, as are all of DTC's rules and procedures, as a contract between DTC and its participants."

Note to DTC (if you are reading this): in footnote 3 of the letter you reference an internet address where the Omnibus Proxy Procedures are available; but it doesn't work. Please let me know the correct URL.

Another letter to set the record straight comes from the Society of Corporate Secretaries and Governance Professionals. I have been eagerly awaiting the Society's letter, and when I saw its name with a submission on October 27, I opened it right away. What I found however was the following brief statement:

"The Society submits this letter in response to the letter filed by the Shareholder Communication Coalition on October 20, 2010. We would like to clarify that we do not support the positions taken in the Coalition letter except for Section III relating to Proxy Advisory Firms. We note that the letter has no indication of the names of the members of the Coalition, but the website includes the Society as a member. For this reason, it is possible that one could infer that all members of the Coalition agree with all the points made in the letter. However, as stated above, the Society does not."

Some useful comments on U.S. proxy voting system come from a couple of UK listed companies that also have ADRs traded in the U.S.  Both BP p.l.c. and British American Tobacco p.l.c. submitted letters on October 22, identifying in places, contrasts with the U.K. system. Fortunately you don't need to read both letters to get the point, since they are nearly word-for-word identical - so just pick one: BP or BAT.

The Center On Executive Compensation (COEC) focuses its October 25 letter on the role of proxy advisors (like ISS).  The COEC calls for the registration with the SEC of proxy advisors under the Investment Advisers Act, subject to certain minimum criteria for the number of clients they serve. In addition, the COEC states that registration is not enough and that the SEC should take several additional steps including banning the practice of firms providing proxy advisory services to investors while simultaneously selling consulting services to corporate issuers on the same, or substantially similar, subject matters.

The Comment Letter Cornucopia

The deadline for comments on the SEC concept release ended October 20, and as reliable as Old Faithful, there was a gusher of letters pouring into the SEC in the last few days:  15 on Oct. 18; 30 on October 19; and 68 on October 20.  More continue to dribble in.  I'll be particularly interested in seeing the Society of Corporate Secretaries and Governance Professionals' letter when it arrives. I've got my work cut out for me.  So much to read, digest and tell you about.

Still, it's not as many comment letters as I would have expected -- for the possible overhaul of the U.S. proxy voting system and maybe the single most significant influence on the corporate governance of public companies other than state law.  The number of comments received pales next to "proxy access".  The SEC staff does note that there have also been about 167 submissions of the "form letter" variety to the effect that "the U.S. Chamber of Commerce and the Business Roundtable are pressuring the SEC to rewrite the U.S. proxy system. These groups want companies to have greater control over proxy voting by shareholders. ... I urge you [the SEC] to consider the interests of shareholders before making any changes to the existing proxy system that generally works well."  But numbers aren't everything. This is difficult stuff.  We are not starting from a clean slate.  There are people with vested economic interests at work.  Tough policy decisions with worries of unintended consequences.

Here's a pet peeve of mine.  Why do some submit comment letters using the employer's letterhead when the letter is not on behalf of the employer? Academic professors seem to be the most notorious.  Do they first ask permission of the president of the university or law school?  But publicity is good (for the school), unless the person says something really stupid. 

The SEC's website doesn't allow you to search the comment letters, but I've made it simple.  Just try this:

Registrar & Transfer says competition is needed to improve the proxy voting system

Registrar & Transfer Company (R&T) submitted its comment letter to the SEC on October 4.  I know R&T has been a transfer agent for a long time, but I didn't realize that they have been in the business for over 111 years.  According the letter, they currently provide transfer agent services for more than 1,050 issues (wonder how many issuers) and act in the capacity as proxy distribution agent and tabulator for more than 790 shareholder meetings annually.  R&T pulls no punches in its opening salvo:

"We have long observed that the current street proxy system provides a disservice to retail and institutional investors, generates excessive expenses for issuers and directly contributes to the decline in voting of beneficial retail shareholders."

R&T then goes on to deliver, among other things, a number jabs at Broadridge before hitting them with a hard uppercut.

Here are some recommendations R&T makes [for the most part, excerpted text from the letter]:

Over and Under Voting - Require Pre-Reconciliation. The SEC should require brokers and other financial intermediaries to produce a reconciled eligible voters list as of the record date for each shareholder meeting, in essence, a voting registrar. With today's technologies already in place, these electronic lists could easily be combined across brokers and custodians with the registered shareholder list and used by the inspector/judge of election to verify and authenticate voting. Pre-reconciliation of voting rights should be mandated before an intermediary transmits record date beneficial owner information to a centralized data aggregator (currently Broadridge Financial Services). This should occur before proxy forms are mailed and proxies not Voting Instruction Forms ("VIFs") should be distributed. 

Tabulation Accuracy and Recordkeeping - End the VIF. Every shareholder, registered or beneficial, should be allowed to vote using a registered proxy card designed by the issuer in lieu of a VIF. A proxy card, with the company's logo, larger font and a plain English description of the agenda items being voted on is far more likely to be recognized as a valuable voting form by individual shareholders. This would also facilitate end-to-end validation and vote confirmations. Shareholders, both registered and beneficial, should have the same voting rights and be able to be recognized at the meeting. A single voting register also enhances the ability of issuers to communicate with their shareholders and increase voting.

Fees and Competition - End the Broadridge Monopoly to Lower Costs.  The prices for proxy distribution and communication services for beneficial accounts are controlled by a single vendor hired by almost all brokers. [R&T for some reason doesn't name the vendor -- it is Broadridge.] Comparing fees charged by the street to issuers with fees charged by this company for comparable services indicates that issuers may realize a savings of 40% to 80%. This is not an exaggeration.  The distribution of proxy materials to beneficial holders must be opened up to free market competition where the party bearing the expenses chooses the vendor. A competitive environment would allow issuers to choose a proxy/communications agent not only on the basis of price but also on the quality of service and innovative products. Excessive cost restricts and discourages issuer communication with beneficial shareholders. To accomplish this, the current functions of beneficial owner data aggregation and proxy communications distribution must be separated. Data aggregation of shareholder information between brokers and issuers/transfer agents already exists in several forums. The Depository Trust Company and the Securities Information Center, both subject to SEC oversight, have established communication links with brokers and transfer agents and transmit shareholder information regularly. Separating these functions will provide public companies with the opportunity to select a distribution provider of its own choosing in a competitive market environment. Having a not-for-profit utility, or for profit, regulated entity, processing records at a relatively nominal cost would encourage issuers to further engage their shareholders and increase proxy voting participation.

NOBO/OBO Shareholder Designation - Eliminate OBO. Permitting the issuer to distribute a proxy card in a uniform format to all shareholders and have a single register for voters will encourage voting and permit all shareholders to vote at the meeting. The NOBO/OBO designation is outdated and many investors simply do not understand these classifications. Eliminating this enables transparency of share ownership and direct communications between issuers and their investors. Shareholders can still have the option to remain anonymous through the use of a custodial or nominee account.

Implementation - Changes Wouldn't Take Too Long.  The process can be modified within a relatively short time period. Many of the service providers are already in place providing parallel services for registered shareholders. R&T is already prepared to handle additional proxy distribution and tabulation volumes and has the proven programming and system expertise to consolidate file voting registrars. The development of a data aggregator can be accomplished through a bid process.  DTCC is also a natural repository for this service and, as a not for profit depository under SEC jurisdiction, could provide cost-effective data aggregation services.  It may be argued that the legacy expense or sunk costs incurred by [Broadridge] warrants retention of the status quo so that this firm should be the data aggregator. There is nothing that would prevent [Broadridge] from competing in a free market along with other participants for data aggregation and tabulation and, as a transfer agent, transfer and other registered shareholder services. However, there is no justification for pre-determining the vendor for this service.

Stay tuned.  I bet Broadridge has something to say about this too.

Not everyone believes that the current proxy system needs fixing

Almost all comment letters on the concept release so far have favored significant changes to various aspects of the current proxy system.  But not this one.  Glenn Greenberg, on behalf of the clients of Brave Warrior Advisors, a long-only asset management firm with $1.1 billion invested in U.S. equities, writes: "I want to deliver a clear message: the current system works!  Don't try to 'fix' it."

The letter's principal focus of concern, however, is preserving the anonymity of shareholders and the privacy of investment strategies. The letter states:

"Our clients (and the financial system) benefit when we are able to make our investments largely in private; were our decisions to be made public more frequently than the required quarterly Form 13-F filings, copycats might emulate our positions, mitigating our ability to buy in scale at attractive prices. This in turn would discourage the vital research function we perform."

I don't believe that current thinking on proxy plumbing reforms is for public disclosure of the identity and investments of all shareholders, but in this day of data aggregation and high speed computers and communications, widespread "investor profiling" is possible -- leaving aside the issue of data breaches.  A discussion of privacy concerns regarding possible NOBO/OBO system modifications can be found in the white paper published by the Council of Institutional Investors.

Also according to the letter, "The current system works because it separates issuers from overseeing every aspect of the proxy system. The deck is already stacked in favor of issuers' managements."  It foreshadows that "were issuers to have access to all shareholders or greater control over vote tabulation, we would anticipate further entrenchment of imperial executives and rubber-stamp Boards." Not a pretty picture.