Heart of Darkness: The Problem at the Core of the US Proxy System and its Solution
Centre for Financial Regulation and Economic Development Working Paper No. 1/2010
46 Pages Posted: 27 Oct 2010
Date Written: October, 25 2010
Voting rights are a shareholder’s main legal channel to exercise control internally over the company in which she invests her savings. Under the corporate law of the US states, a shareholder is someone registered on the stockholders’ list, not a person who has title to shares. When in the 1970s transferring paper certificates became impossible on high-volume markets, Congress ordered that the market’s securities be put into the vaults of a central depository and that claims against the depository’s accounts be transferred rather than the shares themselves. Once this was done, however, issuers no longer knew who owned their shares; they only knew a depository or its broker participant was registered as a shareholder. The heart of the securities market went dark. Communications with shareholders became impossible, so to facilitate the delivery of proxy materials to shareholders, the SEC formulated “shareholder communication” rules, which require financial intermediaries to pass along proxy packets to their customers for a fee. As this process is complex and the deadlines short, votes get lost and misattributed. An entire industry has sprung up to help issuers distribute proxy materials and collect votes. Issuers, who the law forced to give shareholder data to intermediaries, now pay these same intermediaries for information services. But paper certificates, the cause of this dilemma, are rarely used in contemporary securities markets. So why does the problematic system still persist? Because it generates a substantial transfer of wealth from the issuers to the financial intermediaries, and the latter understandably do not welcome its dissolution. This paper shows how the indirect holding system impedes the effective exercise of voting rights, exposes the interests that support the system’s persistence, and proposes a practical solution for the disintermediation of securities settlement, which will allow the restoration of issuer-shareholder transparency.
Keywords: Corporate Governance, Corporate Law, Proxy, Securities Settlement, Clearing and Settlement
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