Dysfunction at the ballot box

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Your ballot is marked and cast – but will it count?

We are not talking about a provincial or federal election. Instead, it is corporate elections for board members and shareholder resolutions that are a growing concern.

Davies Ward Phillips & Vineberg LLP is poised to release a massive report that lead author Carol Hansell, one of Canada's pre-eminent lawyers on matters relating to corporate elections, hopes will kick start a discussion on the problems in Canada's system of shareholder voting.

Her firm's efforts are paralleling a similar discussion in the United States. The federal regulator there, the Securities and Exchange Commission, has begun to overhaul its proxy-voting system for the first time in nearly three decades. It's taking comments with the possibility of devising changes in the new year.

"The mechanics of voting are quite broken," says Ms. Hansell, who spent the tail end of last week in Washington conferring with the SEC. "There is no telling if [your vote]will be counted, or counted in full."

The fear is that, just as in democracy, a lack of faith in the system by voters – in this case, shareholders – will undermine the foundation of corporate governance.

What makes a corporate election different from a political one is the disconnect inherent in the system.

Some investors are the "record owners" of their shares, and their names are listed in the company's records. Yet most investors – both individual and institutional – hold their shares through an intermediary, such as a brokerage house, in what's called "street name."

These shareholders have to give instructions to the intermediary on how to vote the shares for them (hence, the term "proxy circular" because of the voting by proxy). The intermediary often hires a third party to manage the process, introducing another player into the mix.

It is, says Stephen Griggs of the Canadian Coalition for Good Governance, "a big spaghetti mess. Securities regulators have been trying to deal with these issues for years."

The proxy voting system is regulated primarily under securities law, Ms. Hansell and her co-authors write in the paper, soon to be released at www.shareholdervoting.com.

"That regulation ends when investors give their voting instructions to their intermediaries. How the votes are tabulated and proxies are cast are completely unregulated. Moreover, securities regulators do not monitor compliance with those aspects of the system that they do regulate."

One firm, New York-based Broadridge Financial Solutions Inc., handles the vast majority of the proxy services for companies in the United States and Canada.

Broadridge's Independent Steering Committee, which includes representatives of public companies, the intermediaries and the companies they serve, has already urged the U.S. regulators to be cautious. "There is much about the current system that works well and [we]are concerned with any proposal that would radically overhaul or cause an upheaval in the current market system."

One of the chief problems seems to be over-voting, where some shares are voted more than once. The intermediaries compile the lists of shareholders eligible to vote at an annual corporate meeting, but the lists aren't typically reconciled with other intermediaries' lists. If a shareowner has lent his shares to another party, they, too, might be listed as eligible to vote.

Companies often toss out the extra votes without any idea whose vote was counted and whose was not.

In its comments to the SEC, Otter Tail Corp., a $700-million market capitalization company in Fergus Falls, S.D., confirmed the problem.

"We experience almost every year an over-voting situation from our beneficial votes," wrote Loren Hanson, the company's assistant secretary. He said the company counts votes up until the broker or other intermediary's number of votes is reached, and "any remaining votes are simply not counted."

"Although we have never had a closely contested meeting where dropping over-votes would impact the outcome of the meeting, we feel uncounted votes disenfranchises holders from the voting process and, in some cases, the votes dropped could represent holders who have more of an economic interest in our company than the ones that were counted," Mr. Hanson said.

Mr. Hanson refers to another problem, that of "empty voting," where shareholders have voting rights that exceed their economic interest in the company. (Example: Buying a put option to sell the shares while still retaining full voting rights.) "There is no question that empty voting occurs," Ms. Hansell said. "The problem is that there is no way to determine how extensive it is."

While much of the focus is on shareholder protection, there are questions about changes that may benefit the companies.

The street-name system also allows shareholders to shield their identities from the companies they own, declaring themselves as "objecting beneficial owners," or OBOs in shorthand.

Ms. Hansell suggests Canada "revisit the commitment" to having OBOs even though it is "one of the hallmarks of the Canadian (and U.S.) proxy voting system."

"The fact that companies cannot communicate directly with many – today almost half – of their investors makes the communication process much more complicated," she said.