Mark Hynes - thoughts on corporate disclosure

Opinions on changing rules, changing best practices, and their effect on investor relations officers.

Thursday, February 15, 2007

“Empty voting” – is it of concern to you?

Business is booming in the lending of shares. That business has nearly doubled in the past five years, according to one report. And with companies reporting that 40% and beyond of a company’s free float is lent at any one time, the issue is of growing concern to issuers.
A recent story in The Wall Street Journal reports on the phenomenon of “empty voting” in corporate governance in the US financial markets, and credits 2 US university professors with inventing the term. Investors use a simple way to profit from the workings of public companies: Borrow their shares, and then swing the outcomes of their votes.
In some cases, the strategy has allowed speculators to gamble that a company's stock will drop, and then vote for decisions that will ensure that it does -- without their ever having to own any stock themselves. Some outside interests have used the strategy to hide their voting power within a company until the last moment. Others of course deny that this practice exists – or at least is commonplace.
Stock lending began as an informal practice among brokers who had insufficient share certificates to settle their sold bargains, often because the owner had mislaid their certificates.
Today, however, securities lending is an important business, whereby securities are temporarily transferred by the lender to the borrower, who is then obliged to return the securities on demand or at the end of the term.
However it highlights 3 issues of concern to issuers.
First, if the lending investor is not aware that their stock is being lent, then they make have problems voting their intentions, and IR’s seeking to build relationships, and with a significant vote coming up, can be misled.
Second, stock being lent in volume is sometimes an indicator that a company’s equity is being shorted, perhaps by a hedge fund. Registrars can often help in identifying patterns which may be stock lending and shorting.
The third issue is whether there may be some element of double counting of votes. For voting effected through Crest, this should not be a problem, as Crest ensures accurate counting. However where the vote is exercised through a proxy form, companies need to ensure that votes are being exercised properly.
What is the regulatory position? The FSA is promising to consult on the wider issue of disclosures of “non material” positions, including stock lending. And one of the largest pension-fund managers, Hermes, is said to have called for regulators to outlaw voting altogether by borrowers of shares.
Meantime, the challenges in identifying and managing voting intentions by investors who have lent their shares, continue.


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