The Council of Institutional Investors, an organization of some 300 pension funds and investment-related firms responsible for more than $3 trillion of pension assets, is pleased the New York Stock Exchange has established a proxy working group to consider Rules 452 and 465—the NYSE’s “broker may vote” policy; and the rules governing transmission of company reports to shareowners.
Both rules are linked to the integrity of the proxy voting process, and as a result, both are of significant interest to Council members, who on average invest about 45 percent of their portfolios in domestic stocks—many of which are traded on the New York Stock Exchange.
The Council is honored to have the opportunity to provide comments on two issues of such interest to Council members. The issues are related yet distinct, and the Council urges the working group to not limit reforms to a “package” deal involving both rules.
I. BROKER VOTING
Rule 452, adopted in 1937, allows brokers to vote on certain “routine” proposals—including the uncontested election of directors, the ratification of auditors, and an increase in authorized common stock—if the beneficial owner hasn’t provided voting instructions at least 10 days before a sch eduled meeting.
Council members believe that brokers should never be permitted to vote on any item without express instructions from beneficial owners, and the Council has long urged the New York Stock Exchange to abolish Rule 452. The Council does not object to broker votes being included for quorum purposes. We do object to broker votes counting toward the passage or failure of any ballot item.
If the exchange is unwilling to abolish Rule 452, we urge the NYSE to correct the most problematic aspects of the rule. In particular, we believe the exchange’s definition of a “contest” should be revised, and its classification of “uncontested” elections of directors as “routine” should be changed.
In the absence of any reforms, we urge the NYSE to ask the Securities and Exchange Commission to amend the disclosure rules to provide a detailed breakdown of the number of broker votes (for, against, withhold, abstain, etc.) cast on each routine ballot item.
Council Recommendation—Abolish Rule 452
The Council believes Rule 452—now nearly 70 years old—is out of date and unfair to shareowners. In the Council’s opinion there is no public policy justification for the current “broker may vote” policy. We base this position on the following market realities:
- In today’s market/governance environment, no ballot item submitted for shareowner approval is so “routine” that brokers should have the ability to vote on the matter without instructions from the beneficial owners.
- Rule 452 taints the integrity of the process by giving brokers—who have no fiduciary obligation to vote the shares in the best interests of beneficial owners—the ability to stuff the ballot box for management.
- Guessing the motivations of the beneficial owners who do not vote is not the job of the NYSE. It is impossible to know whether beneficial owners are fully aware or in the dark that brokers are voting their shares without their instructions. Rather than spending time on this issue, the Council urges the NYSE to address the fundamental problems with the rule.
- Broker votes are no longer necessary for quorum purposes, as concluded in a working paper (attached) by Jennifer Bethel and Stuart Gillan. If the NYSE determines that broker votes are necessary for quorum purposes, we urge the group to amend the rule so that the votes may only count toward satisfying quorum requirements.
Alternative Approaches
The Council will be disappointed if the NYSE chooses to not abolish Rule 452. In this unlikely event, the Council recommends that the NYSE amend Rule 452 to: (1) prohibit broker voting without instructions on any proposed election of directors; and/or (2) formalize a definition of “contest.” The Council also urges the NYSE to call on the SEC to expand the disclosure requirements for broker votes.
Election of directors: The current NYSE rule prohibits broker voting on uncontested elections of directors, including elections subject to a “just vote no” challenge led by one or more owners. The Council believes the interpretation is outdated and recommends that the NYSE amend Rule 452 to prohibit proxy voting without instructions on any election of directors.
Today the election of corporate directors is anything but routine. In fact, the Council and many experts in the governance field would argue that the election of directors may be the single most important vote cast by shareowners at annual and special meetings.
It’s time for the NYSE to prohibit brokers from voting without instructions from beneficial owners when the matter to be voted upon is a contested or an uncontested election of directors.
Definition of “contest:” Currently, Rule 452 prohibits brokers from voting uninstructed shares on 18 enumerated categories. Most of the categories are no longer applicable today. But one category has grown more important and complex over the years: the carve-out for any proposal that “is the subject of a counter-solicitation, or is part of a proposal made by a stockholder which is being opposed by management (i.e. a contest).”
The exchange does not define “contest” in the listing rules, but the Council understands that the NYSE currently limits “contests” to those situations when shareowners solicit against management using a separate proxy card and mail the materials to other shareowners. ADP also uses this definition when it determines whether an item qualifies for broker voting.
In the Council’s opinion, there are several significant problems with this definition.
- It fails to classify “just vote no” campaigns—when shareowners urge others to withhold votes from directors—and other exempt solicitations as “contests.” The idea of withholding votes from directors was suggested nearly a decade ago by former SEC commissioner Joseph A. Grundfest. Companies have tacitly endorsed this strategy by encouraging investors to focus on directors and director independence, rather than on specific governance issues. The Council suspects that directors facing “just vote no” campaigns consider these contested elections, and there can be no doubt that investors leading these efforts consider them contests.
- It fails to recognize the use of the Internet. This problem has been evident in previous years when shareowners—generally smaller owners—have run online proxy fights. In several cases, the owners filed definitive materials at the SEC but didn’t mail materials. As a result, ADP didn’t classify the votes as contested. The NYSE needs to modernize its rules to address these types of solicitations.
- It places Automatic Data Processing, a publicly traded company that is the dominant proxy delivery firm, in an inappropriate and severely conflicted role of determining whether an item is a “contest” and ineligible for broker votes. ADP—an entity hired by brokers, given the authority to cast broker votes and paid by issuers—profits when it mails proxy materials, and it is paid more for contested situations. It is unseemly that Rule 452, which is largely administered by ADP, is currently interpreted in a way to ensure that shareowners must mail materials—and as a result, pay ADP—before ADP will declare their efforts “contests.”
- It is overly complex and is not consistent with current securities laws.
The NYSE’s current definition of “contest” is not in step with the realities of today’s marketplace. The Council recommends that the NYSE change its interpretation to classify as “contested” any situations in which investors file definitive proxy materials with the Securities and Exchange Commission or which qualify as “exempt solicitations” under Rule 14a-2(b)(1) of the Securities Exchange Act of 1934.
Shareowners should be required to provide evidence of their exempt or non-exempt efforts to the NYSE, ADP and any other parties involved in determining whether an item qualifies for broker voting. Once the required evidence is forwarded to the appropriate parties, the proxy item should no longer be deemed “routine” and eligible for broker votes.
This interpretation is simple, consistent with the securities laws and removes third parties such as ADP from the process. This approach modernizes the NYSE’s definition by reflecting changes made to the securities laws by the SEC more than a decade ago.
Reflecting the reality that it no longer makes sense for the NYSE to require physical delivery of proxy materials in order for a vote to be considered “contested,” the proposed definition recognizes that legal proxy contests may be run exclusively using the Internet and without involving ADP or the U.S. Postal Service.
The proposed definition also recognizes the validity of “exempt solicitations,” as codified by the SEC’s 1992 amendments to the Securities Exchange Act of 1934. These amendments were approved to facilitate shareowner communication and enable shareowners to share their support for, or opposition to, management or third party proposals or nominees.
Disclosure: The Council will be very disappointed if the NYSE chooses to not make any changes to Rule 452. In this unlikely event, the Council urges the NYSE to join the Council by calling on the SEC to amend the disclosure requirements to require a breakdown of broker votes (how many were cast “for,” “against,” “withhold,” “abstain,” etc.) on each relevant ballot item.
This important information will provide definitive information about the need for broker votes for quorum purposes and the impact of the votes on final tallies.
II. NYSE ROLE IN SETTING FEES
Today the proxy distribution business is largely a monopoly, with one U.S. company—ADP, a NYSE-listed company—dominating the business. Since 1937 the NYSE has required companies to reimburse member firms for the costs of transmitting proxy materials to owners, and since 1957 the NYSE has been involved in some way with reimbursement rates.
The Council has consistently questioned the propriety of the NYSE setting or approving fees paid to a NYSE-listed company. And the Council has long expressed concerns that the NYSE regulated fees and resulting “fee sharing” (a.k.a. “rebating” or “cost recovery”) arrangements between ADP and the major brokerage firms have stifled market innovation and deterred competition.
Maintaining the highest quality system for proxy distribution and vote tabulation is of paramount importance to Council members. The Council is interested in ensuring that communications processes are as efficient and effective as possible.
The Council believes the current system, which has grown in an ad hoc manner over the years and largely fails to recognize advancements in technologies, could be significantly improved. Unfortunately reforming the system has seemed impossible, largely because powerful groups, including ADP and Wall Street brokerage firms, have resisted meaningful changes to the current systems.
Issuer-shareowner communications have grown increasingly important and complex. The Council believes the working group’s consideration of the reimbursement rates should be tied with a broader SEC-led review of the shareowner communications rules, including the NOBO/OBO rule.
Changes should be carefully considered and implemented to ensure minimal disruptions to the issuer-owner communications processes. Any new system should remove the NYSE and the SEC from the business of setting fees for a publicly traded company and overseeing a monopoly.
If the NYSE is to continue to serve as a rate-setter for ADP’s monopoly business providing shareowner communication and proxy delivery services, we urge the following:
- The NYSE should incorporate a utility ratemaking approach—cost coverage plus a reasonable return—to setting the reimbursement rates. Any changes should be recommended or approved only after a detailed review of ADP’s actual and anticipated future costs. Reimbursement rates, which were last updated in 2002 and are in need of updating, should be regularly reviewed. The NYSE should publicly disclose the findings of these regular reviews.
The Council was very disappointed that the 2002 fee proposal was drafted without any analysis of ADP’s current profitability or returns. The Council found it irresponsible for the NYSE to develop a fee structure for a monopoly business without any information at all about the profitability of the monopolist.
- The NYSE should carefully review ADP’s “fee sharing” arrangements with brokers and consider regulating reimbursement for broker costs. We believe these payments amount to kickbacks and client lock-ups (at least one ADP contract with a brokerage house extends 20 years) and suggest that the fee structure is too generous. Brokers say these fees cover their costs of providing information about beneficial owners to ADP, but the Council questions these claims. Rumors persist that the fee sharing arrangements are profit centers to brokers covering other costs not related to beneficial owner information.
If the NYSE remains comfortable setting fees for ADP, it should extend its oversight to regulate the reimbursement rates paid by ADP to brokers. Such regulation would help remove the stench of ill-dealing that surrounds these arrangements.