As 2012 began, the Basel Capital and Dodd-Frank reforms had not yet been distilled into working regulations. In the case of Proxy Access, the courts rejected the SEC’s reforms in 2011 following a challenge from the Business Roundtable.
Repairing the corporate governance process was the purpose of the SEC’s Proxy Access rule, by which significant shareholders could attach reform ideas to a company’s proxy mailings. Business groups felt such a process could distract and impede management’s own efforts. Active shareholder groups felt they needed to jump-start the reform engine, not just sell off their stock at companies with embedded boards. The courts ruled that not enough work had been done to quantify the pros and cons of Proxy Access.
However, in one area of corporate governance, there is a solid consensus: both managers and shareholders have agreed that “empty voting” is wrong. The SEC, Council of Institutional Investors and Business Roundtable have all agreed that it would be unfair for hedge funds to borrow shares from pension funds before corporate elections, then register and vote against the interests of the lenders’ beneficiaries. Great concern has been expressed by academics, regulators and market participants over empty voting, although there has been no consensus on the direction of reforms.
As a rule, pension managers cannot understand why they are denied the right to vote their shares which are placed on loan. They point out that their loaned shares continue to fluctuate in value on their books, while borrowers must repay dividends to them. Why should lenders not similarly retain the right to vote their proxies?
Many corporate managers agree. We would rather, they say, have more votes from shareholders with long-term interests than from activists with a strictly short-term viewpoint. Furthermore, the time and expense to achieve quorum would likely be reduced if long-term shareholders held on to the right to vote.
Yet, current practice in the securities lending markets transfers the vote to the borrower. Legal research has shown that current practice in the U.S. can be improved without the necessity of new SEC regulations. Transferring the vote is a contractual convention that can be amended in the agreement between the borrower and the lender. In fact, the Global Master Securities Lending agreement (GMSLA) contains an existing provision to permit a borrower to vote upon the instructions of the lender. Such a provision is consistent with the Code of Best Practices of the International Corporate Governance Network, a multidisciplinary advocacy group.
To retain that right to vote, an institutional lender merely has to reference the GMSLA provision within its agency lending and borrower agreements. Lending agents need only arrange to place loans with those borrowers who are willing and able to assign proxies to lenders upon request. After that, the voting process continues as usual.
The process of lender directed voting has been endorsed by large shareholders in letters to the Securities and Exchange Commission and reported favorably by the media.
It may well be that empty voting is also a non-issue in global markets, just as it is in U.S. markets. However, there is no U.S. Federal Reserve Regulation T to prevent the abuse of borrowed proxies in global markets, an action that might alter the direction of a strategically important company at a critical time in its future. The institution of lender directed voting would put the matter to rest.
Institutional lenders, those with a substantial economic interest, would retain the right to vote in corporate annual meetings, even when their shares were out on loan across the record date.
To further explore the implications of this socially meritorious evolution in financial markets, the Center has initiated a live pilot in 2012 to allow institutional lenders, agents and securities borrowers to work out the procedures for lender directed voting. read more