Monday, January 29, 2007

Empty Voting

The lead story in Friday's WSJ, "How Borowed Shares Swing Company Votes" adressed the topic of "empty voting". In empty voting, equity shares are lent/borrowed prior to their record date and returned afterwards. This has traditionally entitled the borrower to the voting rights. Through this practice, borrowers can establish control over a large block of votes without mantaining any continued economic interest. Empty voting can be used to promote interests other than those of the fiduciary shareholders.

It has grown along with the securities lending business. Estimates of the size of the equity securities lending markets are in excess of US$700 billion, with significant participation from mutual funds, pension plans, endowments and insurance companies. The history and issues involved in Empty Voting are outlined in both the referenced study by University of Texas professors Hu and Black and by Charles Nathan in his article “Empty Voting” and Other Fault Lines Undermining Shareholder Democracy: The New Hunting Ground for Hedge Funds.

Securities lending and the separation of voting rights from the economics of stock ownership may be of concern for plan fiducaries. Legally, a transfer of title normally occurs when a security is loaned. Therefore, fiduciaries may have no explict responsibility to follow ERISA proxy voting rules as established in the DOL Interpretative Bulletin on Proxy Voting.

However, language in the Bulletin might broadly suggest that fiduciaries have an explicit responsibility to weight the benefits associated with securities lending activity against the "value" of voting rights and the potential that those rights could be voted in a manner that is contrary to participants best interests.
" the responsible fiduciary consider those factors that may affect the value of the plan's investment and not subordinate the interests of the participants and beneficiaries in their retirement income to unrelated objectives.....The named fiduciary must carry out this responsibility solely in the interest of the participants and beneficiaries and without regard to its relationship to the plan."
Though the extent of empty voting is unknown, the potential costs and conflicts of interest of securities lending may be growing larger than prudent fiduciaries can ignore. Fiduciaries should be aware of any securities lending activities that involve their plan assets. They should also inquire about how their agents prevent or detect abusive activity.


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