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Note: The subject of the interview below, Cary I. Klafter, is a member of the Forum's Program Panel for "Say on Pay."

For additional reports concerning regulation of investor communications and voting processes, see


Metropolitan Corporate Counsel, May 4, 2009 interview


The Society of Corporate Secretaries & Governance Professionals
Systemic Defects In Proxy Voting Machinery Undermine Good Corporate Governance

Published: May 04, 2009
Mr. Klafter is Chair of the Public Company Affairs Committee of the Society of Corporate Secretaries & Governance Professionals ("Society").

Editor: Please tell our readers about your background and professional experience.

Klafter: I was with the Morrison & Foerster law firm in San Francisco for 24 years prior to going with Intel - which is my first and only in-house job. I joined the Society shortly after I started at Intel and have been a member for 12 years.

Two of the significant strengths of the Society are in facilitating its members in business networking and benchmarking, plus the Society's influential role in shaping national policies affecting corporate securities regulation and the governance of corporations. The membership consists to a large degree of folks who are engaged in those activities at more than 2,500 public corporations, and we also have members affiliated with securities and governance service providers such as proxy solicitors, transfer agents and others involved in the shareholder communications and voting process. There is a wealth of experience, and the membership is pleased to speak with each other. Suggestions are only a telephone call away.

Editor: Tell us about the Society's position on the NYSE's amendment to Rule 452 to eliminate broker discretionary voting for the uncontested election of directors.

Klafter: Rule 452 is simply one aspect of the current system of shareholder communication and voting; it allows brokers to vote retail customer positions on "routine" matters (per definitions of the New York Stock Exchange) when the shares have not been voted by the customers. Our position on Rule 452 and a number of other proposals relating to shareholder voting is that these individual rules should not be revised in isolation because each is only one part of a much bigger and more complicated system. We believe that there will be many unintended consequences to come if attempts are made to change one piece of the system at a time without having first reviewed all of the system and its constituent parts and developed a master plan for reform. We have been exhorting the SEC to step in and adopt reforms only as part of a "bigger picture" look at the topic. As proxy voting becomes more and more prominent and meaningful it becomes more important to take a fresh look at all aspects of the system.

In the particular case of Rule 452, this rule is linked to retail voting. The current major trend with respect to retail voting is that the retail vote has apparently been dropping in recent years; in some cases retail investors are moving to institutional, managed vehicles such as mutual funds and are no longer voting shares of individual issuers, and in some cases the retail investors with individual stock holdings are simply not voting. As the retail vote drops, voting power has been moving more and more towards institutional holders because almost 100 percent of them vote. The institutions vote for many reasons: they see the value of the vote; they are in some cases required by law to vote; and they are pushed to vote by clients or are required by many clients to vote for shares that are held in the managed accounts. The institutional voter can outsource the voting activity in the same way in which it can outsource the buy-sell decisions, and it can use sophisticated electronic voting platforms that allow for the relatively easy voting of hundreds or thousands of positions during the annual meeting season.

The retail voter is in a different position. The retail vote continues to drop in part because no one other than the issuer is pushing those shareholders to vote, and there is little education for them about the voting process. Survey data shows that many retail voters assume that the broker will vote account shares for them as customers, and as a result they believe they have no need to vote on an individual basis.

Part of the theory underlying Rule 452 going back to the 1930s was that it would be a way for shares in retail accounts to be voted in circumstances where you didn't have a specific direction coming to the broker from the clients. And under our legal structure, which is oriented to record (as opposed to beneficial) ownership, the broker is the record owner and so is a logical person to be voting. For some issuers the Rule 452 vote can be the difference between the presence of a quorum or not in attendance at the annual meeting.

The director-election amendment to Rule 452 was strongly supported the by institutional voter community. They see the retail votes cast by brokers under current Rule 452 as being reflexively management oriented and so perhaps counter to their interests. However, surveys show that the actual retail voting pattern correlates very closely with the pattern followed by brokers when voting uninstructed shares. So, the brokers' vote is in fact a fair reflection of their retail customers' preference. In some cases brokers have adopted what is known as proportional voting instead of voting uninstructed shares on a discretionary basis. The brokers look at the retail vote of the customers who have voted and then vote the remaining unvoted shares in a manner proportional to how the voting customers voted. In such cases, their vote does not represent any discretion on their part at all - their vote is a mirror image of how their customers who actually voted cast their votes. The adoption of the Rule 452 amendment could result in other voting alternatives like proportional voting being prohibited.

The Society and others pointed out to the SEC that their own expressed concerns about retail voting would not be advanced by adoption of the 452 amendment. We have requested that the SEC consider other measures, such as allowing the inclusion of a proxy card in the initial mailing for a Notice & Access solicitation, and recommended that any changes to 452 be undertaken only as part of a "big picture" review of the shareholder communications and voting system. In our view, the recent and future changes in corporate governance will result in every vote on the annual meeting agenda being a potential "contested vote." We need the best and most up-to-date system available to facilitate communication and voting before (not after) the inevitable scandal erupts.

Editor: I understand that the Society is supporting the recommendations of the Millstein Center with respect to proxy advisers and institutional investors.

Klafter: That is true. We have been very focused on the role of proxy advisers and institutional investors. If you rewind the tape to 20 years ago or even 10 years ago, you did not have anything like today's influence of proxy advisers. A very large proportion of shares are voted in accordance with the recommendations of RiskMetrics, Glass Lewis and Proxy Governance - and in some cases they are given blanket authority simply to vote on behalf of their clients in accordance with such recommendations.

The SEC has done little in the way of regulation or oversight of proxy advisers notwithstanding that it is an industry that plays one of the most significant roles in corporate governance. Compare this situation with the time and effort the SEC has spent focusing on credit rating agencies. If you read the SEC's transcripts of their inquiries into credit rating agencies, all you have to do is change the names of the industry players and you are struck by how close the analogy is between credit rating and proxy advisory services with respect to conflicts of interest, direct market influence and how the service providers are operated. Who are their employees? What educational standards are applied to their analysts? How transparent are processes used to establish their policies and procedures? To what extent are recommendations tailored to the circumstances of the issuer and based on quality research?

Editor: Is the need for greater regulation of proxy advisers illustrated by their increased influence on policy issues? Take say-on-pay for example.

Klafter: There has been commentary by SEC commissioners and by various members of Congress about adopting say-on-pay as a mandatory requirement of federal law. The theory is that it pushes corporations to engage in more consultation about compensation with institutional investors in the ramp-up to the proxy season.

If say-on-pay becomes federal law, the agenda item will be in the proxy statement of every public company every year. This means that every year, every proxy voting adviser is going to issue a recommendation effectively relating to the totality of your company's executive compensation. However, the recommendations that will be delivered will inevitably be based on a one-size-fits-all analysis because the adviser can't spend a lot of time analyzing the individual executive compensation pictures at each of the public companies.

An issuer will either meet the algorithmic requirements of the proxy voting adviser or not. In some cases you won't be informed of the standards of the adviser until the recommendation is issued; in other cases you can pay the adviser a few thousand dollars in advance of the vote to try to figure out whether you will or won't meet the standards of the algorithm. Meanwhile, best of luck to you as an issuer during the off-season when you try to contact your top 100 stockholders to consult with them about your compensation plans. Will they return your call, will they have any policies that guide their voting, do they care about the topic at all in relation to their buy-sell decisions about your stock? Will they care at all about the topic in a "routine" year without special proposals on the ballot? When will they fit you in when their other 7,000 portfolio companies call for a meeting time? Consultation is valuable and appropriate, but it will take all relevant parties to be ready, willing and able.

Editor: Aren't naked voting and overvoting also illustrations that the machine is broken, because you can have the right to vote a proxy even when you have no economic interest in those shares?

Klafter: There are market participants out there who, after having spent their time with credit default swaps and other interesting devices, have now been able to figure out how they can vote without owning shares. In a worst case that could be a threat to the entire corporate governance system. The Society has sought to address those issues by pushing the SEC to require among other things more disclosure from the persons holding those positions. We pointed out specifically that the rules on stock ownership disclosure in 13D, for example, (which required the filings for five-percent and ten-percent holders) do not encompass these new developments, and they ought to do so. The current shareholder communications system effectively prevents public companies from knowing who their shareholders are; as you might imagine, it is even more difficult to figure out who holds a non-stock interest in our voting shares and our economic future.

Editor: How do these defects in the voting system play into the proxy access issue?

Klafter: Chairman Schapiro and others at the SEC have said explicitly that the SEC intends to move on the proxy access topic once again. The last time it was considered the issue proved to be extremely contentious. Several of the current commissioners have given the clear impression that this time around proxy access will be adopted and the only open question is the exact content of the rules. Will you have to accommodate 100 nominees each year, nominated by anyone with $2,000 value of your shares; or will there be some arbitrary limitations in the rules based on number of nominees, holdings of the nominating parties or the occurrence of some triggering event of some nature?

So, imagine a world where every director election is contested. The vote is now even more important than it was before; 452 is more important; the ability to have a routine audit of vote results is more important; the expense and inefficiency of the NOBO-OBO rules are more important; and the ability to communicate with investors is more important. Proxy access is another part of our "big picture" worldview, and it should be considered in concert with numerous other parts of the proxy voting system.

Editor: It was interesting to me that few of the issues that are the focus of the Society's attention were specifically addressed by Mary Schapiro in her April 6 speech to institutional investors.

Klafter: The core issue for issuers, and I would think for all longer-term investors, is the fact that Rule 452 is just one facet of a much greater and jury-rigged machine affecting shareholder communications and voting. There is a need for the SEC to take a look at all aspects of that machine and all of the participants in that machine. This is as worthy a topic as was the National Market System, which the SEC thoughtfully studied and ruled on over an extended period of time, and which effort began with a holistic review of all that was then in place and which then led to expressed goals and only then to new regulation. I commend your readers to the Web site of the Shareholder Communications Coalition, of which the Society is a part, which contains materials on all of these topics.



2008 The Metropolitan Corporate Counsel, Inc.





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