By Eleanor Bloxham, contributor
The alarm bells regarding the abusive back
office processes of mortgage servicers were ringing back in 2007, but they
mainly fell on deaf ears.
Katherine Porter's 2007 review of 1,700 cases
Misbehavior and Mistake in Bankruptcy Mortgage
Claims concluded that "a majority of mortgage
claims lack the required documentation necessary to establish a valid debt",
fees are charged that "do not appear to be legally permissible", and that
"the bankruptcy system routinely processes mortgage claims that cannot be
validated and are not, in fact, lawful."
state regulators sought federal regulatory
assistance three years ago due to foreclosure issues
they had uncovered at Bank of America (BAC)
and JP Morgan (JPM).
The regulators were ignored by the Office of the Comptroller of the
Despite the warnings, it was not until
people losing their homes in record numbers began to speak out that the
issues really came into the spotlight,
forcing banks to seriously review and own up
to issues with their internal processes.
Now, silently, there is another back office
issue brewing that may soon come to a head, this time at brokerage houses.
While not as devastating as losing a home, the issue goes to the very heart
of capitalism -- losing your shareholder vote. Because of poor record
keeping and a lack of regulatory oversight today, your vote, as a
shareholder, may not be counted.
How this happened
Your potential lack of suffrage stems from
a fix to make back office recordkeeping easier for brokerage firms,
according to Carol Hansell, an attorney with Davies Ward Phillips and
Vineberg and co-author of
The Quality of the Shareholder Vote in Canada.
This fix came in response to the "paperwork
crisis" of the 1960s. At that time, "a brokerage firm in the United States
needed 33 different documents to execute and record a single securities
With stock market volume soaring by 400% in
one decade, brokers were straining to keep all the paperwork straight. As a
result, Congress mandated a change to the system. Because of this change,
most shares you buy are recorded by your broker and share certificates are
held centrally rather than mailed directly to you.
Sounds like a good solution and it could
have been just fine.
No one thought too much about creating a
system to accurately record the voting rights of your shares.
As Ms. Hansell points out, in redesigning
the process for share purchases and sales, shareholder votes just weren't
considered that important and "the systems were never designed" to make sure
the vote counts were accurate.
How big is the problem?
The problem has gotten to the point that
votes closer than a 10% spread are not
callable, according to Gil Sparks, a leading Delaware
attorney, quoted in a 2008 report published in the Georgetown Law
That is highly disturbing, given the close
elections we've seen in U.S. boardrooms this year. In the
Massey boardroom, for example, in May, two of
the three directors up for reelection won reelection by a margin of 10%,
according to SEC filings.
At The Pantry, Inc. (PTRY),
earned 47% in support of reelection and 53% against, while three directors
earned 48% for and 52% against.
And research suggests that
incumbents are overwhelmingly more likely to
win than lose reelection by small margins.
Why the interest now?
Although ensuring accurate vote counts has
been a festering problem for years, increasingly, shareholder votes do
Just as increased share trading volumes
helped fuel the 1960s broker paperwork crisis, which led to reforms in
processing, and just as "foreclosuregate" has come to a head with increased
volumes of foreclosures, the interest in shareholder voting is picking up
steam because of the increased number of issues shareholders are being asked
to vote on (say on pay as one new recent example) and the growing importance
of shareholder votes themselves (as director elections move to require
majority votes for election, for example).
Couple that with increased shareholder
activism and a new focus worldwide on the obligation, as well as the right,
of shareholders to vote, and you have the stirrings of what could become a
very contentious battlefield over whether votes were counted, over-counted,
under-counted or otherwise distorted.
And the discussion is not theoretical. Over
the past few years, there have been numerous reports of materials not being
delivered in time to shareholders, confusion around who owns shares, and
votes not counted.
Just two weeks ago,
the issue of voting irregularities was raised
in an SEC filing by Carl Icahn, reported on by
The New York Times' Dealbook.
filing stated Icahn's view
that "the Dynegy/Blackstone merger severely undervalues the Issuer" and that
"In addition to demanding appraisal rights under Delaware law, [Icahn]
intend[s] to investigate any potential voting irregularities."
In July, the SEC published a concept
release on a wide spectrum of issues concerning shareholder votes.
The Securities Transfer Association's white paper that
summarized comments on the SEC release
said that many issuers have expressed concern with the collection and
counting of their shareholder's votes and believe that reform is necessary.
The International Corporate Governance
Network (ICGN) offered similar concerns, stating that
share voting record-keeping practices are in
need of an upgrade.
The recommendations for reform make sense
-- and they are akin to keeping a list of eligible voters in a government
election. But why, if it's so obvious, hasn't it been done?
It likely comes down to the fact that
brokerage houses don't have an economic incentive to clean up their act.
"The regulatory push here is needed because
broker-dealers may have insufficient incentives to get this right on their
own," writes Henry Hu and Bernard Black in
Equity and Debt Decoupling and Empty Voting
II: Importance and Extensions.
Smith Barney's comment letter on the SEC's concept release
confirms this: "Requiring brokers to change reconciliation methods … would
impose costs and implementation difficulties that would far outweigh the
advantages of imposing one method to the exclusion of the other."
So where is the Financial Industry
Regulatory Authority (FINRA), the overseer of broker dealers, in the
FINRA did not provide comments on the
concept release and didn't have a comment related to its current role or its
future plans in this area.
For shareholders with elections this
spring, will their votes count or will we continue to have a situation where
we just don't know?
Darren Robbins of Robbins, Geller, Rudman
and Dowd, the law firm that pursued Enron on behalf of investor victims,
says on close shareholder votes you have to "wonder about their veracity".
And the implementation of the Dodd-Frank financial reforms will only make
these issues more acute, he noted.
"While mechanisms to track votes in single
situations may be possible, to recreate them in 10, 20 situations, could put
a real strain on the system. The SEC should be compelled to look at this,"
An SEC spokesperson said that it is
evaluating public comments related to their concept release with next steps
to be determined. The spokesperson did not know what the timeline might be
or the extent to which FINRA may be involved.
One suggestion before next proxy season?
The SEC and FINRA will be holding a broker
dealer seminar on Feb. 8, 2011, at the SEC's Washington, D.C. headquarters.
Shareholder votes -- and knowing who is
entitled to vote -- should be on that agenda.
Eleanor Bloxham is CEO of The Value
Alliance and Corporate Governance Alliance (http://thevaluealliance.com), a
board advisory firm.