On September 22, the HLS Forum on Corporate Governance and Financial Regulation posted an article (The Promise of the Enhanced Broker Internet Platform) from John Endean, President of the American Business Conference, a coalition of CEOs of mid-cap companies. I attempted to post a comment on the HLS Forum but it appears to have fallen through the cracks. Mr. Endean begins as follows:
A breakthrough for improved corporate democracy is languishing at the Securities and Exchange Commission. The breakthrough, called the Enhanced Broker Internet Platform (EBIP) is a technological innovation that would make it vastly easier for shareholders to participate in corporate elections for directors and shareholder resolutions. This is important because the rate of individual or “retail” shareholder voting is pitifully low. For example, in fiscal year 2012, the rate of retail positions voted was less than 14%.
Mr. Endean purports to speak for retail shareowners, but employs only a thin disguise.
Given that there are 140 million votable retail positions, any effort to increase the voting of those positions would result in a more accurate measure of shareholder sentiment regarding the resolutions put forth by activists or, for that matter, by management. It would more clearly gauge the popularity (or unpopularity) of directors seeking election to corporate boards. In a very real sense, greater shareholder voting is a crucial part of investor protection.
However, from his comments to the SEC, it appears he and the mid-cap CEO members of the American Business Conference (an organization whose one and only press release appears to have been in December 2010; more articles here), are more interested in essentially restoring broker votes than defending the rights of retail investors. He appears to want to restore the old system where proxies not directed by retail shareowners were voted as recommended by current (possibly entrenched) boards.
Historically, most retail shareowners toss their proxies. During the first year under the “notice and access” method for Internet delivery of proxy materials, less than 6% voted. This contrasts with almost all institutional investors voting, since they have a fiduciary duty to do so. “Client directed voting” (CDV), a term coined by Stephen Norman, is seen by many as a solution for getting more retail shareowners to vote, ensuring companies get a quorum, and helping management recapture a good portion of the broker-votes cast in their favor that evaporated with recent reforms. An open form of CDV, could result in similar impacts but would also create much more thoughtful and robust corporate elections.
Retail investors are the principals in the principal-agent system of corporate governance. We are the beneficial owners of all equities – in the U.S., 25 to 30 percent via direct purchases, and 70 to 75 percent via our “ownership” of shares in mutual funds, pension funds and other intermediaries. The agents in our corporate governance system include CEOs, boards of directors, institutional investors, proxy advisory firms, compensation consultants, etc. An “Open Proposal” on CDV will improve the accountability of all these agents to the principals by empowering retail investors with better information and voting tools.
Since Stephen Norman coined the phrase in 2006, the concept of CDV is generally attributed to him and his work with NYSE’s Proxy Working Group. Looking back at the origins of the concept, on October 24, 2006, the NYSE filed a proposed rule change with the SEC to eliminate all broker voting in the election of directors. Two months later in December 2006, Steve Norman presented a proposal called Client Directed Voting to an investor communications conference.
The case for CDV was again made on the Harvard Law School Forum on Corporate Governance and Financial Regulation by Frank G. Zarb, Jr. and John Endean (available here). Similar to Norman, the voting options presented were severely restricted to the following: (1) in proportion to other retail shareholders; (2) in a manner consistent with the board’s recommendation; or (3) in a manner that is contrary to the board’s recommendation.
John Wilcox’s post several weeks later, Fixing the Problems with Client Directed Voting, helped to expand and popularize the concept beyond Norman’s initial concept with a much more open proposal.
Shareowners and the SEC would be well served to review the work of Mark Latham, a member or the SEC’s Investor Advisory Committee, who proposed something similar to CDV at least as far back as the year 2000. See The Internet Will Drive Corporate Monitoring and other papers on the VoterMedia.org Publications page). In stark contrast to Norman, Latham’s proposed system is open and competitive, using a market-driven framework. This post builds on his work, especially Latham’s recent post, Client Directed Voting Q&A, also found on the VoterMedia.org site.
How Open CDV Would Work
Open CDV enables retail shareowners to implement a specialization strategy similar to that of institutional investors. Most fund managers do not read the proxy statement and understand the proposals in the context of a company’s particular circumstances. They have specialized staff for that review, some in-house, some out-sourced. Likewise a few retail shareowners will read proxies, but most will not. Those who do not read them can increasingly be informed by those who do and by voting announcements posted on the Internet.
With an Open Proposal, anyone can create a voting feed, just as anyone can now create a blog. One way to create a feed is to remix other feeds, just as blogs often post or link to material from other blogs. A remixed feed can select different source feeds for different stocks or different industries or different categories of voting matters (director elections vs. shareowner proposals etc.). In his article The Internet Will Drive Corporate Monitoring, Latham called remixed feeds “meta-advisors.”
Engagement requires either a fiduciary obligation, which we won’t have for retail shareowners, the perception of value in the process (which may take years to establish) or passion around relevant issues. Of the three, passion around relevant issues will be the easiest to ignite.
Many third-party platforms or voting feeds will be designed around “issues,” rather than harder to understand policies and procedures. That will naturally appeal to a broader base of retail shareowners. More people will choose voting advice around policy concerns, like global climate change, than around procedural concerns, like whether or not the roles of board chair and CEO should be split.
A small but important percentage of retail shareowners will get more involved in helping to determine voting feed reputations. They will compare feed quality and issue/value identification by such means as creating focus lists at ProxyDemocracy.org. See, for example, this page.
Most retail investors will only pay attention to the best-known voting feeds. A small minority of institutional and retail investors, along with writers in the financial media, are likely to become the most influential opinion leaders helping to determine public reputations, and thus which of potentially hundreds of voting feeds deserve to be followed.
Investors should be able to choose voting feeds and instruct our brokers to implement them for our shares. That is powerful because it takes little time, yet can implement intelligent voting based on reputation – just as the reputations of carmakers and computer makers are widely available and influence our purchases.
There is already a healthy base of “brands” developing with Domini, Calvert, Florida SBA, CalSTRS, CalPERS and others announcing a growing number of their votes in advance of annual meetings. In addition, there are plenty of other sources of voting advice besides institutional investors, many of which focus on a limited number of issues and many can already be seen at MoxyVote.com.
Moxy Vote has already built an open CDV platform on a relatively low budget. Proxy Democracy and Transparent Democracy can be readily enhanced to include voting capability if the SEC adopts additional data standardization and if cost reimbursement is forthcoming from issuers. See comments submitted by MoxyVote.com to the SEC here.
Essential Elements of Open CDV
The key issue in any open CDV system is to let shareowners control where their electronic ballots are delivered. Just as there is no question shareowners can control where hardcopy ballots are delivered, there should be no question they can direct where their electronic ballots are delivered. This simple requirement would insure third-party content providers an opportunity to compete and improve the quality of voting advice.
Additional elements for a more effective CDV system include:
- A wide range of voting opinion sources that will eventually cover all issues;
- Open access for any new opinion sources to publish their opinions;
- Open access for shareowners to choose any opinion source for our standing instructions on voting;
- Sufficient funding for professional voting opinion sources that compete for funding allocated by retail shareowner vote (or by beneficial owners of funds that may choose to “pass through” their votes).
Under an Open CDV system, feeds will offer the ability for retail shareowners to essentially build a “voting policy,” just as institutional voters are now able to do. That model will increase participation and voting quality. We shouldn’t ask shareowners to affirm every single pre-filled ballot. That could be a deal breaker for people with stock in many different companies who would rather spend their time on other activities.
Third-party CDV systems, like Moxy Vote, will allow investors to create hierarchies of voting instructions. (Vote like X. If X hasn’t voted the item, vote per Y. If Y hasn’t voted, vote per Z, etc. Eventually, these systems could become very complex. Vote like X on issue A; vote like Y on issue B, also specifying defaults if either X or Y don’t have votes recorded.)
If brokers are required to deliver proxies as directed by their clients, another whole model could emerge around “proxy assignments.” Proxies assigned to organizations or individuals, for example, could give annual meetings a new meaning. See Investor Suffrage Movement by Glyn A. Holton.
In the 1940s and 1950s thousands of shareowners frequently showed up for shareowner meetings because they frequently deliberated issues and some of those in attendance held substantial proxies from others. Lewis Gilbert, for example, was often given unsolicited proxies, which he used to negotiate motions at meetings.
Impact of Open CDV
We are a long way removed from those days and advance notice requirements would preclude much of the activities Gilbert made famous. Voting at meetings is important, but having a say in setting the agenda on what will be voted on is even more powerful. If a significant number of proxies are assigned to others or thousands of shareowners routinely follow specific voting advisors or institutions, leading voices can actually begin to influence how agendas for annual meetings are set.
An Open Proposal will increase both the quantity and the quality of voting by both retail and institutional investors. Ease of voting and the ability to align with valued brands will drive quantity. Increased quality will result from competition between voting opinion sources for reputation in the eyes of investors. Opinion sources will include institutional investors, retail investors, bloggers, activists and professional proxy voting advisors funded by new mechanisms discussed later in this article.
An Open Proposal will cause retail shareowners to engage in proxy voting because it offers several new and powerful ways for us to do so, while respecting our other interests and time constraints.
Additionally, institutional investors will begin to discuss their votes with each other more frequently, as well as with beneficial owners and funds. This is already happening. I have personally initiated such dialogues with several funds and have increasingly been met with a favorable response. As funds learn how and why other funds are voting, many are open to reexamining their own position.
Director elections in particular will be more closely watched, once shareowners gain a sense of empowerment. Prior to nascent CDV sites, we had little or no basis for voting against or withholding votes from individual directors. Soon we will be able to drill down through recommendations to discover which directors are over-boarded, miss meetings, have potential conflicts of interest, were on compensation committees that overpaid executives, etc. Funds will increasingly provide the reason for their votes, since that will drive more investors to vote with them. When a fund discloses not only their vote, but also the reason for their vote, investors get a better picture of their values and we begin to trust given “brands” as consistent with our own values.
Limiting CDV to only selected situations, like uncontested elections, would only lessen the benefits of CDV, so I don’t recommend imposing any such limits. It would be better not to establish any CDV through regulations that severely limits voting options, since once such systems are enacted they will be difficult to amend, given that those who benefit from such limitations will be in an even stronger position to fight opening up the process.
All matters should be eligible for inclusion in a CDV arrangement. All can be handled the same way, with the retail shareowner voting as per standing instructions to use specified voting feeds. Preferably, systems should allow users the ability to override standing instructions in any given situation. Competition among voting feeds will encourage those who create them to constantly improve their voting quality and reputation. One improvement is to adapt their analysis and voting decisions to the significant variation among proposals on any given matter. Another is to create industry specific analysis. Analysis could also vary by a company’s maturation and/or a great many other factors. Deeper levels of analysis are more likely with open CDV systems that enhance competition.
The default choice should either be whatever the shareowner selects or it should be a “not voted” vote, just like if a voter fails to mark an item on the proxy, that item should be left blank, although it is now often counted in favor of management. (See my petition to the SEC for a rulemaking on “blank votes” here)
Counting a blank vote as anything else would make mounting campaigns to deny companies a quorum much more difficult. Neither brokers nor anyone else should be permitted to vote on any ballot item in the absence of voter instructions (i.e., all items should be considered non-routine matters in NYSE rules).
Brokers/banks should not be forced to take on CDV design responsibilities. Other third-party specialist firms will probably do a better job. The key is to ensure that brokers or their agents deliver ballots to whomever the shareowner directs. Of course, it would also be a plus if brokers and banks would make their clients aware of the available options.
Competition for Funds Would Enhance CDV
I would recommend an ongoing competition open to providers of investor education, which would compete for funding allocated by retail investor vote. This could be limited to education about voting issues (informing CDV, providing voting opinions, organizing voting opinion data feeds, discussing reputations etc.), or voting could be included in a broader retail investor education competition. For more explanation, see Mark Latham’s Voter Funded Investor Education Proposal (November 30, 2009).
This would benefit all retail investors. Since the benefit is shared broadly, it should not be paid by individual retail investors, but rather through funds that we own collectively – corporate funds. There are several possible ways of arranging this. One example is Mark Latham’s Ultimate Proxy Advisor Proposal (June 1, 2010).
Under that proposal, companies pay voting advisors selected by their shareowners. Since there are no “free riders” and the advice is essentially paid for by all shareowners, we can pay much more for proxy research on our companies than current proxy advisors typically allocate. Additionally, the advice we get is less likely to be of a “box ticking” nature, more likely to be industry and company specific.
The SEC should encourage the development of shareowner selected proxy advisors by amending rule 14a-8(i)8 to allow shareowner proposals that would allocate corporate funds to those who undertake to offer proxy voting advice, including advice on director nominees, that is made freely available to all of a company’s shareowners.
In the near term, the entrenched agents in our corporate governance system may try to prevent investors from using our funds to empower ourselves this way, so enabling regulations from the SEC and public funds may be helpful to get started. Public funds earmarked for retail investor education and advocacy could be used for the first such initiatives.
Cost categories for CDV include: (a) creating voting opinion feeds; (b) system development for brokers; (c) vote processing by Broadridge and similar service providers.
If the SEC publicly encourages the development of CDV, many organizations are likely to build the necessary systems. As previously mentioned, voting opinion websites have already started appearing (ProxyDemocracy.org, TransparentDemocracy.org, MoxyVote.com). To enhance their quality, public funds earmarked for retail investor education and advocacy could be allocated by investor vote among such competing providers of tools for CDV.
CDV will increase the quality of voting and decrease the quantity and costs of paper mailings. These benefits will outweigh the costs of building CDV systems. Standardized data tagging will likewise streamline the system and reduce costs in the long run, although it will require some up-front investment.
NYSE rules currently require payment by issuers for the cost of voting electronically but issuers may not always be making such payments to CDV platforms like Moxy Vote. See NYSE Rules 450-460 pertaining to proxy distribution, available here. The Rules are actually written for “member organizations” (i.e., brokers) and specify what brokers or their agents (e.g., Broadridge) can charge for distribution and collection of proxy-related items. The rules are clear that Issuers are supposed to pay for all of the distribution (and collection) costs and that brokers can expect to collect from them. These rules should be amended to apply to Issuers when shareowners choose to take delivery of proxies or to vote through sites like Moxy Vote, RiskMetrics, Glass Lewis and ProxyGovernance.
The fees that Broadridge is charging to electronic voting platforms (RiskMetrics, Glass Lewis, ProxyGovernance, Moxy Vote, etc.) should be paid by the issuers as part of the overall collection costs (like postage). The electronic platforms, in this function, are merely an extension of the proxy distribution agent. However, I understand that Broadridge charges on the order of 10X for electronic vote collection from these platforms than it is permitted to charge the issuers.
If Broadridge is offering a “value-added” service to these electronic platforms, where is the “baseline” service that costs less? Perhaps the value-added services revolve around the ability to turn blank vote into votes for management without following the rules that apply to proxies. (See my blog post, Jim Crow “Protections” for Retail Shareowners)
My understanding is that fees are charged to electronic platforms on a “per ballot” basis (generally one fee per position per year) and that electronic platforms are generally passing along these costs to voters. That becomes much more difficult, perhaps impossible, when trying to service retail shareowners with small position sizes and many more per ballot transactions, relative to shares voted.
This is, in effect, becomes a system where the voter is paying to vote, like the old Jim Crow poll tax. It also inhibits progress (i.e., the development of electronic platforms for retail shareowners) because voting through the mail and through the phone is free. Why should retail shareowners have to pay when voting online, which is inherently the least expensive method of voting? Why should services like Moxy Vote have to front such expenses? Without a change, it is hard to see how they can ever turn a profit and it seems even less likely that nonprofits, such as Proxy Democracy, would ever be able to offer users the option of voting on a Proxy Democracy platform. Such costs need to be eliminated or minimized if a robust open CDV system is to mature.
The NYSE should consider forcing Broadridge to direct some of its “paper suppression fees” to firms like MoxyVote.com that should be sharing in this incentive, since shifting to electronic from paper voting saves money. That would be a simple way of beginning to address the cost issue. The most fundamental point regarding costs is that issuers should bear the actual cost of voting, not shareowners or CDV systems.
An open CDV system improves corporate governance because voting advisors will make it easier for shareowners to meaningfully participate in voting, without having to read through proxies. Open CDV systems do this by allowing shareowners to informally build individualized proxy voting policies, much like formal policies maintained by many institutional investors. Unlike many institutional investors, who may ponder over their voting policies for months, retail shareowners will mostly build default policies based on brand identification. Voting advisors, chosen by shareowners through competitive markets for shared information, will help make agents more accountable and democracy in corporate elections an emerging reality.