On November 15, 2018, John Zecca, Senior Vice President, General Counsel North America, and Chief Regulatory Officer of Nasdaq Regulation for U.S. Markets, participated in the SEC's Proxy Process Roundtable. Prior to his appearance at the roundtable, Mr. Zecca submitted a comment letter to the SEC advocating key changes to the proxy rules on behalf of public companies and retail investors. Highlights are provided below.
Nasdaq operates 19 regulated entities in the United States and Canada, including the Nasdaq Stock Market, which is home to over 3,000 public companies and exchange traded products. Nasdaq is also a listed company and is subject to the same regulations as other public companies, including the proxy rules.
A common theme we hear as we talk to our listed companies (and our own experience confirms this) is that the proxy process is costly, inefficient, unduly complicated, and requires a disproportionate share of management's attention. Specifically:
- Companies routinely cite the proxy process as one of a series of complaints, which, in the aggregate, discourages them from joining the public markets.
- Despite its cost and complexity, the current system results in a disproportionately few number of retail investors voting their shares.
- The current outdated proxy process also limits a company's ability to communicate with shareholders—especially younger retail shareholders—in the digital way that they prefer to communicate.
In my letter to the SEC dated November 15, 2018, we urge the Commission to address the cost and difficulties for companies to communicate with shareholders; reform the rules related to shareholder proposals; and require transparency about the methodologies and conflicts of proxy advisory firms, as well as a mechanism for companies to address errors by the firms. Excerpts from this letter, which address each of these issues, are provided below.
Proxy Voting Mechanics and Technology
The primary purpose of all aspects of the SEC's proxy rules should be to facilitate communications between companies and their shareholders. In this digital age, it is notable how incredibly complex and expensive it is for companies to communicate with their shareholders, especially their retail shareholders.
Problems fall into three broad categories:
- Lack of transparency as to beneficial ownership. Companies consistently report that there is over-voting and under-voting in their proxy elections, in part as a result of double-voting in connection with security lending. Shareholders express frustration that they have no way to verify that their votes have been counted.
- The proxy process makes it impossible for companies and shareholders to communicate in the way retail shareholders expect to communicate today. Because of the complexities of the proxy system, and particularly the distinction between objecting beneficial owners (OBOs) and non-objecting beneficial owners (NOBO), companies often don't know the identities of their retail shareholders, making it impossible to contact them directly. Even when companies do know shareholders' identities, for proxy-related matters they must contact them through expensive intermediaries.
- Companies are frustrated they are charged fees that they cannot negotiate. Issuers receive large, obscure annual bills from intermediaries that they did not select, for delivering proxy materials. In addition, while notice and access has improved the proxy system considerably, companies still pay a large amount in printing fees each year because intermediaries report that large numbers of stockholders have requested full set delivery of proxy materials. Issuers have little ability to contest, or even deconstruct, the annual bills they receive. Companies would like to reach out to those stockholders to encourage them to use technology to receive materials, but again, the proxy system makes it difficult to identify and contact them. Even where they can use electronic delivery the cost to do so remains high.
As a technology company, Nasdaq knows there is a better approach—and Nasdaq's eVoting initiative has shown that it is possible. We have conducted proof of concept tests in Estonia and South Africa that use a cryptographically secure transaction private ledger to address many of the current challenges of the proxy process, including the lack of transparency and traceability in the voting process. In the Estonian market, we were able to use the national identity numbers issued to each resident to help establish each digital identity in this market where investors directly hold their securities. Users in South Africa, which has a central securities depositary (similar to the US), access eVoting via a web enabled front end; the system records the data on the blockchain. The system can also accommodate the transmission of voting-related materials and, of course, the audit trail and immediate vote tally functionality is available through permissioned reports that provide different levels of information to issuers and shareholders and, if needed, auditors and even regulators.
We are hopeful that technology will one day enhance many aspects of the proxy process, but in the meantime the SEC should consider the following actions:
- Revise rules to permit direct communication between companies and their shareholders.
- Consider assigning the cost of the OBO designation to those shareholders whose status force those costs.
- Give issuers a say in selecting intermediary providers and ensure transparency to companies about the fees they pay, giving them the ability to ensure that those fees are correct.
- Enhance the integrity of the shareholder vote by improving transparency and the mechanisms to reconcile long and short positions, thereby better limiting voting, and the cost of proxy solicitations, to only those persons entitled to vote.
Another cost that public companies face is related to the shareholder proposal process. Many companies spend thousands of dollars and countless hours of management time addressing proposals from proponents who own minimal amounts of their shares.
Nasdaq proposes the following amendments to Rule 14a-8:
- Increase the minimum ownership percentage to ensure that shareholders have a meaningful investment in the company before they are given access to the proxy.
- Delete the meaningless $2,000-dollar threshold and instead require that a proposing shareholder hold a material investment in that issuer.
- Increase the holding period to a longer period, such as three years, which would help ensure that management and boards spend their scarce time focused on shareholder proposals that come from shareholders who are aligned with other shareholders in the long-term success of the company.
- Increase the resubmission thresholds, so companies aren't burdened year after year with proposals that the majority of their shareholders don't support.
In addition, shareholder activists are increasingly using Notices of Exempt Solicitation on Form PX14A6G to advocate for certain proposals and policy issues without subjecting their materials to review by the company or the SEC. As a result, communications about a shareholder proposal that would otherwise be excluded from a Company's proxy statement in accordance with Rule 14a-8 can nonetheless be presented to shareholders on a Form PX14A6G, which can be filed at any time prior to or after an annual meeting.
Nasdaq proposes that the SEC revise the "cover" in Rule 14a-103 to clearly identify the filing party, similar to Schedules 13D and 13G, and require the filing party to disclose the number of shares held and any interest in the proposal or policy issues it is advocating for. The SEC should also consider restricting the time period in which a voluntary Notice may be filed.
Proxy Advisory Firms
Given the number of public companies, the large number of proposals placed on each company's proxy, and the limited time to consider these proposals, institutional shareholders have come to rely on proxy advisory firms. While this service is valuable in theory, in practice the industry is a largely unregulated black box, rife with opacity, lack of accountability and conflicts of interest. Specifically:
- Proxy advisory firms are not required to fully or completely explain their criteria or provide companies a means to question analysis or even correct factual errors.
- Proxy advisory firms are not required to disclose whether they have a financial relationship or ownership stake in the companies on which they report.
- When shareholders rely on the voting recommendations of the proxy advisory firms, it further distances companies from their shareholders.
While the SEC took preliminary steps to address these concerns several years ago by issuing Staff Legal Bulletin 20 , and again earlier this year when it withdrew two no-action lettersconcerning the ability of investment advisors to rely upon recommendations by proxy advisory firms in voting their clients' securities, additional guidance is needed about the impact of this withdrawal and the important underlying concerns that other market participants have with proxy advisory firms.
Proxy advisors must also have a line of communication with the companies they analyze and clear transparency around their ownership of, or short interest in, covered companies. The stories we hear from public companies further bear this out. In one case, in two successive years, a proxy advisory firm based its recommendations on an erroneous and incomplete understanding of the relevant facts. In each instance, the company was told that it could avoid such issues by subscribing to (and paying for) the proxy advisory firm's corporate services.
Each of the above issues are central to the willingness of companies to join the public markets and to retail investors' ability to interact with the companies whose shares they own. Nasdaq urges the SEC to address the cost and difficulties of communicating with shareholders; update the rules related to shareholder proposals; and require transparency about the methodologies and conflicts of proxy advisory firms, as well as a mechanism for companies to address errors by the firms.
Please note that the SEC encourages public companies to submit comments related to these topics. Comments can be submitted here.
For more information, read:
Chairman Jay Clayton's Statement at the SEC Staff Roundtable on the Proxy Process >>
Commissioner Kara Stein's Opening Remarks at the 2018 SEC Staff Roundtable on the Proxy Process >>
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.