Archive for the ‘Rights’ Category

Stock Lending

Stock lending is the lending of securities (including equities, government bonds and corporate debt obligations) to a borrower, with the borrower agreeing to return equivalent securities to the lender at a pre-determined time. The focus of this article is on the lending of securities and, in particular, the potential impact on shareholders’ votes.

Benefits and costs

The International Corporate Governance Network (ICGN) Securities Lending Code of Best Practice (2007) identifies the potential benefits but also the potential corporate governance implications of stock lending.  Benefits of stock lending include that it ‘improves market liquidity, reduces the risk of failed trades, and adds significantly to the incremental return of investors.’  However, there are potentially significant adverse effects on corporate governance in terms of shareholders’ voting rights. The ICGN state ‘Misconceptions as to its [stock lending] nature have led to loss of shareholder votes in important situations, as well as to cases of shares being voted by parties who have no equity capital at risk in the issuing company, and thus, no long-term interest in the company’s welfare. Lenders’ corporate governance policies may also be undermined through lack of coordination with lending activity. It is also imperative that there be as little risk as possible that a poll of the shareholders may be compromised through misuse of the borrowing process.’ The issues identified by the ICGN are very real ones which may have heightened importance in situations where investors are voting on contentious issues.  Resolutions which otherwise may have failed to be passed, may be passed because of the way in which votes secured through stock lending have been cast, and vice versa.

Pauline Skypala in her article ‘Securities lending – kept from view’ (FTfm, Page 6, 5th September 2011) points out that last year the Pensions Regulator advised pension fund trustees and others managing schemes they should be aware of whether scheme assets could be lent and on what terms. In particular, they should know how much of the income earned was passed on to the scheme.

Ellen Kelleher in her article ‘Inquiries starting into “empty voting”’ (FTfm, Page 3, 26th September 2011) gives the example of an activist hedge fund which might briefly borrow shares in a company purely to vote in favour of its takeover at the next general meeting.  This would be legitimate in most markets but can hardly be called best practice.

SCM Private, an actively managed passive investment firm, carried out research which revealed that UK retail fund managers controlling over £241 billion may lend out up to 100% funds but investors would be kept in the dark.  Furthermore, levels of disclosure, transparency and protection within current legislation are, SCM find, totally inadequate.

Meanwhile the Investment Management Association (IMA) has defended stock lending pointing out that they are happy with the level of disclosure required.

ICGN basic tenets of best practice

Lenders and borrowers would do well to take note of the ICGN Securities Lending Code of Best Practice (2007) basic tenets of best practice:

1. All share lending activity should be based upon the realisation that lending inherently entails transfer of title from the lender to the borrower for the duration of the loan.

2. During the period of a stock loan, lenders may protect their rights only with the borrower, since they have no rights with the issuer of the shares which have been lent.

3. Institutional shareholders should have a clear policy with respect to lending, especially insofar as it involves voting.

4. Lending policy should be mandated by the ultimate beneficial owners of an institution’s shares.

5. Where lending activity may alter the risk characteristics of a portfolio, the policy should state the extent to which this is permitted.

6. The returns from lending should be disclosed separately from other investment returns when reporting to clients or beneficiaries. They should not be hidden under management and other costs.

7. It is bad practice to borrow shares for the purpose of voting. Lenders and their agents, therefore, should make best endeavours to discourage such practice.

Concluding comments

Stock lending has ramifications in a number of areas including fee income, portfolio risk, and voting rights. Lenders have a responsibility to be aware of the full implications of lending their shares and borrowers should not borrow shares with the intention of using the attached voting rights to circumvent corporate governance best practice.

 Chris Mallin 16th October 2011


Institutional Investors and Corporate Governance Reform

Corporate governance codes and guidelines have long recognised the important role that institutional investors have to play in corporate governance.  As well as being influential in their home countries, institutional investors have increasingly become a more significant force in other countries through their cross-border holdings. Recent corporate governance reforms motivated by the global financial crisis have placed even more emphasis on the role of institutional investors.

Role of Institutional Investors

Back in 1992, the Cadbury Report recognised the role played by institutional investors  stating that ‘we look to the institutions in particular ‘ to use their influence as owners to ensure that the companies in which they have invested comply with the Code’.  Various codes since then have emphasised the importance of the role.  The Financial Reporting Council (FRC) publishes the UK’s Combined Code on Corporate Governance (commonly known as the Combined Code).  The Combined Code (2008), in Section E, identifies three main principles.  Firstly it states that ‘institutional shareholders should enter into a dialogue with companies based on the mutual understanding of objectives’; secondly ‘when evaluating companies’ governance arrangements, particularly those relating to board structure and composition, institutional shareholders should give due weight to all relevant factors drawn to their attention’; thirdly, ‘institutional shareholders have a responsibility to make considered use of their votes The first and third principles relate to two of the tools of governance being dialogue and voting.  All three principles essentially require institutional investors to behave in a responsible and conscientious way, taking all relevant factors into account and making considered decisions.

Corporate Governance Reform

The UK Treasury commissioned the Walker Review of Corporate Governance of UK Banking Industry which reported in November 2009. The Walker Review recommends ‘strengthening the role of non-executives and giving them new responsibilities to monitor risk and remuneration; it also recommends a stewardship duty on institutional shareholders to play a more active role as owners of businesses.’  Kate Burgess and Brooke Masters in their article ‘Institutions urged to adopt tougher stance’  (FT, Pg 21, 26th November 2009) states ‘Institutional investors are being urged to be tougher on company boards by Sir David Walker, as the City grandee adds his weight to pressure for them to take their responsibilities more seriously.’

The FRC’s statement welcoming the Walker Report can be found at: The FRC has agreed to implement those recommendations that it considers should apply to all listed companies. In addition the FRC has agreed to consult on adoption of a Stewardship Code for institutional investors as recommended by Sir David.   

A recent review of the Combined Code has however recommended that Section E of the Code (addressed to institutional shareholders) be removed, ‘subject to sufficient progress being made on the Stewardship Code for institutional investors and its associated governance arrangements.’  The Stewardship Code for institutional investors as was proposed by Sir David Walker, and is an area on which the Financial Reporting Council (FRC) will be consulting separately

The final report on the review of the Combined Code (2008) makes various recommendations which include, inter alia, annual re-election of the chairman or the whole board; new principles for the roles of the chairman and non-executive directors.  Kate Burgess in her article ‘Sir Christopher misses out on succession planning’ (Pg 21, FT, 2nd December 2009) highlights that more emphasis should have been put on succession planning in companies as this tends to be a weakness in many firms.  Moreover it would be beneficial to investors in their stewardship role to have more knowledge of the process in place for succession planning.

Stewardship Code

The Institutional Shareholders’ Committee (ISC) membership comprises the Association of British Insurers, the Association of Investment Trust Companies, the National Association of Pension Funds, and the Investment Management Association.  The ISC has previously published guidance on the responsibilities of institutional investors in 2002, 2005 and 2007.  In November 2009, the ISC published its Code on the Responsibilities of Institutional Investors which is included as an Annex in the Walker Review and which is widely viewed as the basis for the Stewardship Code which will be monitored for the adherence of institutional investors on a ‘comply or explain’ basis.  The ISC states that ‘the Code aims to enhance the quality of the dialogue of institutional investors with companies to help improve long-term returns to shareholders, reduce the risk of catastrophic outcomes due to bad strategic decisions, and help with the efficient exercise of governance responsibilities.’ The Code discusses the stewardship responsibilities of institutional investors which include effective monitoring of investee companies and voting of all shares held. 

Effective Stewardship

Of course in order to carry out their responsibilities as shareholders, institutional investors need to be able to exercise their rights effectively – if they cannot, then they may be tempted to exit, i.e. to sell their shares.  An article in the Financial Times, ‘Shareholder rights’ (FT, page 12, 30th November 2009) points out that ‘if selling the shares is a blunt instrument, then removing board members is the sharpest.  More than nine in 10 international investors say the ability to nominate, appoint and remove directors is the most valuable shareholder right.  It is wrong that efforts to boost this power in the US have been delayed by the business lobby.’  Clearly it is in the interests of effective stewardship for institutional investors to be able to exercise their rights.  This will enable them to take action on prominent topical issues such as having a ‘say on pay’ in relation to directors’ remuneration, and removing underperforming directors from the board. 

However another dimension to consider is that of free riders.  Ruth Sullivan in her article ‘Walker plan points finger at freeriders’ (FTfm Pg 3, 30th November 2009) points out that some institutional investors will not engage more with their investee companies and be active owners, rather they will save their time and money and free ride on the efforts of other institutional investors. 

Concluding comments

The recent reforms mooted by the Walker Review and the Review of the Combined Code have made recommendations which will help to strengthen corporate governance in the UK.  The role of institutional investors is seen an important one and institutional investors are being encouraged to engage more fully in their role as owners and adhere to the ISC Code of Responsibility for Investors. 

Chris Mallin 2nd December 2009

On Shareholder Democracy: what democracy?

The mid-nineteenth century vision of the joint stock, limited-liability company was exquisitely simple and superbly successful.  Ownership was the basis of power.  Shareholders appointed the directors, who reported regularly on their stewardship over the company. Shareholder democracy was based on one share – one vote. 

 Then something went wrong.  Directors took control.  As long ago as 1932, in research that is still among the most cited in the corporate governance lexicon, Berle and Means showed that power over public corporations in the United States had become concentrated in corporate boardrooms.  What happened to the original notion that power over a corporation should be exercised by the owners?  A similar erosion of shareholder power occurred in the United Kingdom, and indeed in most other countries whose company law reflected the old Commonwealth company law traditions.

 The UK Cadbury Report (1992) and corporate governance codes in other countries attempted to redress the balance by requiring board-level nomination committees, with independent non-executive director members, to put forward the names of potential directors.  But these non-executives, themselves, had been approved by the chairman and CEO, and owed some allegiance to them. The board then put their proposals to the members, who got to vote.  But incumbent directors effectively could re-appoint themselves and, when the time came, appoint their successors.  

 The shareholders of a UK public company can now call for a special meeting of the members, at which a simple majority can vote to remove any (or indeed all) of the directors.  Section 338 of the UK Companies Act 2006, broadly, enables members of a public company to require the company to give all shareholders notice of their resolution, provided they hold 5% of the total voting rights or total at least 100 members.  But the financial risk and uncertainty of such actions make them newsworthy.

 In the United States the situation is worse.  One share one vote still prevails, but the board decides which names get on the ballot paper.  The only way for outsider candidates to get nominated is through proxies circulated to all the other shareholders at the proposer’s expense.  This financial exposure results in most board appointments being uncontested, with incumbent directors keeping their seats around the board room table, with the attendant benefits, even though in practice only a small proportion of shareholders actually voted for them

 Attempts to persuade the Securities and Exchange Commission and state regulators to change the rules have been frustrated by aggressive lobbying from corporate director interest groups.  The latest attempt by the SEC to reform the system was put on hold earlier this year. 

Companies in the United States, of course, are incorporated by individual states. There are no provisions for incorporation at the federal level.  Many companies are incorporated in Delaware, because company law and the Delaware companies’ court tend to be sympathetic to their interests.  But Delaware company law was changed earlier this year to allow companies to reimburse the costs of circulating the names of outsider directors to other shareholders.

 A straw in the wind was reported in the Economist (31 October 2009).  The American company, HealthSouth, a company that runs private hospitals and clinics, which in the past has been criticized for poor corporate governance, changed its corporate governance rules to allow activist shareholders to propose candidates for election to its board.  The company even offered to cover the costs involved, if 40% of the votes were subsequently cast for the outside candidates. 

 In his clumsily titled, but brilliantly perceptive book Corpocracy (Wiley, New Jersey, 2008), Robert (Bob) Monks showed how modern corporations have maximized their wealth, balked at government regulation, and locked-out their shareholders, whilst the executives rewarded themselves with massive pay packages.  Shareholder control over large corporations, he argued, is weaker now than ever.  Not only are these corporations rarely held to account by regulators, they face even less control by those whose interests they are ostensibly there to serve. 

 Bob Monks feels that shareholders, particularly institutional shareholders, should attempt to influence corporate behaviour and governance for the benefit of all shareholders and society. He has called for the United States to adopt the British approach, with a federal statute that would give investors the right to call a special meeting to remove directors. 

 The Economist commented “in a healthy shareholder democracy, such a rule would not be controversial.”

 Bob Tricker



Voting – Having a Say

Voting ones’ shares is seen as one of the main tools of corporate governance.  In recent times, votes have been cast against adoption of the annual report and accounts, against the appointment, or re-appointment, of certain directors, and against certain proposed strategies.  Votes can also be used via the ‘say on pay’ to signal displeasure at executive remuneration packages.  Although the ‘say on pay ‘ (discussed in more detail in this blog on 6th April 09) is an advisory vote, it may nonetheless be quite effective at making boards think twice about the proposed pay packages for executive directors. 

However companies do not always take as much notice of the votes cast as one would like.  For example, the recent annual general meeting of Marks and Spencer is a case in point as regards the use of voting as a (vociferous) voice.  Andrea Felsted and Samantha Pearson (FT Page 17, 9th July 09) in their article ‘M&S chief defiant amid revolt by investors’ highlight that nearly 38% of votes cast backed a resolution seeking the appointment of an independent chairman within the next year.  Sir Stuart Rose, who has been the centre of much criticism since taking on the roles of both chairman and chief executive, did not seem overly bothered by the investors’ views on this matter.  There was also much shareholder dissent over the re-election of the chairman of the remuneration committee and over the adoption of the remuneration committee report.

Withheld votes

Whilst the importance of the vote is universally accepted, let us consider what happens in the UK when a vote is withheld.  A withheld vote may signal that an investor has reservations about a resolution, or it may be a stronger expression that an investor is unhappy about a resolution, whilst falling short of actually voting against the resolution.  However when the ‘vote withheld box’ is ticked on proxy forms in the UK, the withheld votes are not counted as part of the votes cast. 

For example, after its annual general meeting in May 2009, Shell published the voting results on its website.  On Resolution 1 : Adoption of Annual Report & Accounts, there were:  ‘votes for’  3,301,631,965, ‘ votes against’  3,394,595, and ‘votes withheld’ 16,026,721.  However when indicating the percentage split of the votes, ‘votes for’ are shown as 99.90% and ‘votes against’ as 0.10%.   The votes withheld were nearly 5 times that of the votes against but nowhere are they reflected in the percentage totals of votes cast.  Similarly, on Resolution 4 : Re-appointment of Lord Kerr of Kinlochard as a Director of the Company, there were ‘votes for’  3,161,974,849, ‘votes against’  77,443,311, and ‘votes withheld’ 77,876,289.  The percentage allocation indicated 97.61% ‘votes for’ and 2.39% ‘votes against’.  The ‘votes withheld’ which again exceeded the ‘votes against’ were not reflected at all in the percentage totals.  It should be said that Shell does clearly state that “a ‘vote withheld’ is not a vote under English Law and is not counted in the calculation of the proportion of the votes ‘for’ and ‘against’ a resolution.”

The Combined Code on Corporate Governance (2008) under Code provision D.2.1, states that  ‘For each resolution, proxy appointment forms should provide shareholders with the option to direct their proxy to vote either for or against the resolution or to withhold their vote. The proxy form and any announcement of the results of a vote should make it clear that a ’vote withheld’ is not a vote in law and will not be counted in the calculation of the proportion of the votes for and against the resolution.  However it’s interesting to note that a decade ago, the Report of the Committee of Inquiry into UK Vote Execution (1999), published by the National Association of Pension Funds, stated that whilst it was initially attracted to the idea of adding a third box (being an ‘abstention’ or ‘vote withheld’ box), it then decided that there were several arguments against the inclusion of such a third box.  Firstly it might provide investors with an ‘easy option’ so that rather than voting against, they withheld their votes; and secondly since withheld votes are not counted, and have no legal effect, then it could drive down the level of recorded votes. 

However as we have seen, the Combined Code (2008) does advocate the inclusion of a ‘vote withheld’ box on the proxy form.   Therefore, it could be that in practice the addition of a third box which allows a withheld vote but which is not counted, may lead to the understatement of the level of dissatisfaction with some resolutions.  Given that institutional investors are coming under more and more pressure to be seen to be active owners of shares, it may be that a ‘vote withheld’ will increasingly become seen as sitting on the fence, rather than taking a decision to vote against.

In the US, it would seem that abstentions do have a legal effect under a majority voting system.  For example, in a director election if there were more votes withheld than were voted for the candidate, then the candidate would not be elected, hence the abstentions (votes withheld) would have a legal effect.

Broker votes

Turning to US issues, the SEC has recently made some important changes to proxy voting.  Weil, Gotshal and Manges (2009) report that ‘the SEC approved a change to NYSE Rule 452, eliminating broker discretionary voting of uninstructed shares in uncontested director elections, which will have the effect of reducing the number of votes cast in favor of the board’s nominees in the election of directors and strengthen the influence of institutional investors and activist shareholders.’

Blank votes

However James McRitchie has brought to our attention the problem of blank proxy votes which go to management.  He highlights that fact that the broker vote issue that the SEC took care of is ‘where retail shareowners don’t submit a proxy (or voter information form) at all.  When that happens, the broker or bank can vote within 10 days of the meeting. The “blank vote” issue arises when the shareowner votes at least one item on their proxy but leaves some other items blank……..[the voting] platform for institutional investors doesn’t allow submission of blank votes, [but the] platform for retail holders does and the SEC allows them to fill in the blanks as instructed by brokers and banks (always with management)’.  Furthermore he states that ‘As shareowners who believe in democracy, we have filed suggested amendments to take away that discretionary authority to change blank votes, or non-votes, as they might be termed. We believe that when voting fields are left blank on the proxy by the shareowner, they should be counted as abstentions.’

Concluding thoughts

Clearly the area of voting is a complex one and changes are being brought in over time to remove barriers to voting and to help ensure that votes are cast in a way which fairly reflects the owners’ intentions. A decade ago it would have seemed highly unlikely that many institutional shareholders would publish their voting levels in individual companies and on individual resolutions  but many institutional shareholders now do this.  In the US a number of institutional shareholders have gone a stage further and disclose their voting intentions prior to a company’s AGM.  Hopefully institutional shareholders in other countries will adopt this approach in future.

Chris Mallin 10th July 2009.

Rights Issues

Rights issues have been a traditional way to raise funds from existing shareholders in the UK, Europe, and Australasia.  Existing shareholders are offered the chance to acquire new shares, at a discount, in proportion to their existing holding. In general the reasons for a rights issue fall into one of three categories: raising funds for an acquisition or expansion; (ii) internal working capital requirements; (iii) restructuring of the balance sheet.  The latter often occurs in times of financial distress and it is for this reason that many of the companies seeking to raise money through rights issues are doing so now – they need to raise cash, and asking existing shareholders is one of the few ways to do it.

Banks and property companies making most rights issues

It has been noticeable that many UK companies are making rights issues at present.  Many of the companies seeking to raise funds in this way are in sectors particularly badly affected by the economic downturn:  the banking sector and the property sector.

HSBC, in the largest rights issue in UK history, is seeking to raise more than £12 billion from its investors.  Peter Thal Larsen, Neil Hume and Kate Burgess (FT, Page 1, 28th Feb/01st Mar 09) in their article ‘HSBC to seek £12bn in record offering’ state that HSBC ‘is the latest in a long line of global banks to seek to strengthen its capital reserves by issuing shares’.

Peter Thal Larsen (FT Page 19, 3rd March 09) in his article ‘HSBC’s search for capital gives market the shudders’ reports that ‘…the bank’s decision to raise £12.5bn in fresh capital from its investors and cut its dividend for the first time any of its executives can remember was bound to send a shudder through the markets’.  However HSBC is still seen as being in a stronger position than many other banks, and Stuart Gulliver, HSBC Chief Executive of Global Banking and Markets, stated ‘The rights issue is designed to get us a bullet-proof balance sheet’.

In their article ‘Segro to seek discounted rights issue’ (FT, Page 14, Financial Times 28th Feb/1st Mar 2009), Daniel Thomas and Neil Hume highlight Segro is seeking to raise 3300 million and that other property sector companies including Land Securities, British Land, and Hammerson have already approached investors with rights issues to the tune of more than £2 billion in recent weeks.

In similar vein, David Fickling, Kate Burgess and Neil Hume (FT, Page 17, 3rd Mar 09) in their article ‘Debt-laden Wolseley close to launching £1bn rights issue’ highlight the plight of Wolseley, the builders’ merchant whose ‘loss-making retail division [was] heavily exposed to the stagnant US housing market’.

Governance implications

Shareholders taking up the rights will retain the same proportion of the share capital overall as they had prior to the rights issue.  However shareholders not taking up the rights issue shares will have a lower proportion of the company’s share capital than they did prior to the rights issue i.e. their stake will be diluted.  To avoid any dilution that would occur when companies do not offer shares to their existing shareholders first, in some jurisdictions the concept of pre-emption rights (that is, new shares have to be offered to existing shareholders first) has long been enshrined in company law.  However as Oliver Ralph (FT, Page 6, 28th Feb/1st Mar 09) points out in his article ‘The begging letters start to arrive’, noted ‘The institutions are getting uppity because they, too, have been left out on certain occasions. Witness the outrage that Barclays provoked when it raised money from Middle East investors last year.  More recently, Rio Tinto has enraged its institutional shareholders by offering convertible bonds on favourable terms’.

There are clear governance implications where investors’ shareholdings are diluted and equally the investors are somewhat ‘over a barrel’ as if they wish to avoid dilution, they have to pour more money into companies for reasons, and at a time, when they may not wish to do so.

There were also some problems with rights issues last year, including low take-up rates, and claims of market abuse through short-selling, and as a result the Rights Issue Review Group was established and reported back late last year.  The full report ‘A Report to the Chancellor of the Exchequer: by the Rights Issue Review Group’ is available at

Following the Review, the Association of British Insurers (ABI), an influential body representing the collective interests of the UK insurance industry, altered its guidelines on rights issues so that companies will be able to issue new shares amounting to up to two-thirds of their existing issued share capital (previously one third) without obtaining shareholder approval. The purpose of the change is to facilitate rights issues.

Rights issue wave

It remains to be seen how many more companies will make rights issues but at the present time it seems a good option for companies, many of which are  in dire need of a cash injection, although investors may be becoming wary and viewing rights issues as a case of  good money after bad.

Chris Mallin