Hedge Funds Vote (Often)
In Proxies, Borrowed Shares
Fill Ballot Box; SEC May Act
By KARA SCANNELL
March 22, 2007; Page C1
WASHINGTON -- Responding to concerns that corporate elections are undermined by improper voting, securities regulators, a large institutional investor and some corporations are exploring ways to prevent manipulation.
At issue is whether some big investors, including hedge funds, can sway corporate contests by voting shares that they have borrowed but don't own, or hedged to minimize how much they have at stake.
The practice was thrust into the spotlight last year by an academic paper by two University of Texas professors on what they dubbed "empty" voting. Some big companies also have decried the practice, calling it undemocratic and akin to renting votes.
Securities and Exchange Commission Chairman Christopher Cox has asked senior staffers to study the issue and provide recommendations by year's end. "We're focused on both more precisely defining the problem set and on using all of our authorities to tailor appropriate solutions," he says. "I don't want to rule out anything."
Mr. Cox will have to tread carefully. Shareholder votes generally are governed by state lawmakers, not the SEC. Past attempts by the SEC to stiffen securities rules have prompted business groups to sue over alleged encroachments on states' turf. And pension funds and other institutional shareholders make lots of money lending out their shares -- an $8 billion-plus-a-year business.
Restrictions on borrowing shares also would face opposition from short sellers -- investors who sell borrowed shares in hopes of profiting on a stock's fall by replacing them with cheaper ones bought later.
'EMPTY' VOTING
• The Issue: Some professional investors appear to be getting more votes in corporate elections than their shareholdings would normally allow.
• Background: Two University of Texas professors showed how hedge funds could borrow shares and get more control of votes, without the risk.
• What's Next: Could the SEC impose restrictions on borrowed shares? Or make Wall Street keep better track of stocks and votes?
Here's how corporate votes typically work: A company simultaneously sets an election date and a so-called record date that's days or weeks before the vote. Everybody who owns shares or controls borrowed ones on the record date can vote, whether or not they control the shares before or after.
After the record date passes, the company announces what issues will be on the ballot, or proxy -- director elections, proposed acquisitions, governance reforms and the like. Eligible voters than cast their ballots by mail or in person at a shareholder meeting.
One proposed reform involves the record date. The Texas professors found that some hedge funds had borrowed shares on the record date, secured the voting rights and then quickly sold them, minimizing how much they had at risk while gaining influence over the election.
The State Board of Administration of Florida, which manages a $130 billion public pension fund, favors requiring companies to announce the issues up for votes at the same time that they set the record date. That would give share owners time to recall their loaned stocks before somebody else can vote them. Like other institutional investors, the Florida agency doesn't like borrowers voting their shares on important issues, though it makes about $50 million a year from lending stock.
Clear Channel Communications Inc. recently moved to address this issue by rescheduling the election and record date for shareholders to vote on its sale to a group of private-equity firms. Clear Channel said the move would "better align the economic and voting interests" of all its shareholders. The company hopes that by having a shareholder base with more at stake, it will get enough votes to approve the deal.
Mr. Cox, the SEC chairman, is exploring whether keeping better track of stocks and votes would resolve a related problem: overvoting. Proxy ballots sometimes are sent inadvertently to both borrowers and lenders, allowing both to vote the same shares.
Making sure that doesn't happen, however, might require costly overhauls to the record-keeping systems of brokerage firms, which fulfill two roles in this process: They are the middlemen who put borrowers and lenders together, and they send out most of the ballots on behalf of the companies.
Another possible reform involves better disclosure of borrowing and hedging.
Currently, only investors with ownership stakes of 5% or more have to disclose the size of their positions. Academics suggest that there are many savvy investors who purposely stay just below 5% to avoid triggering disclosure. And borrowed shares and hedging techniques don't need to be disclosed, unless the investor owns 5% or more outright.
Increased disclosure, though, likely would be resisted by big investors, who say that revealing their strategies eliminates their competitive edge by allowing other investors to copy their trades.
Philip Goldstein, an outspoken hedge-fund manager who successfully challenged an attempt by the SEC to require hedge-fund advisers to register and disclose information about their firms, has called for less disclosure of holdings.
Further complicating matters: Brokers who facilitate stock loans say there is a fundamental misunderstanding of how their business works, and deny that empty voting is a big problem. These brokers favor making sure investors know that they relinquish voting rights by lending their shares.
Write to Kara Scannell at kara.scannell@wsj.com
AI
