The U.S. Securities and Exchange Commission (SEC) recently confirmed the feasibility of Exxon's implementation of an automatic retail shareholder voting mechanism in accordance with board recommendations. This measure is motivated by the inherently fragmented nature of shareholder capital in American public companies and the passive role of retail shareholders in corporate governance.
Key conditions of the program include openness to all retail shareholders, free participation and withdrawal, annual reminders about participation in the program and the opportunity to withdraw, the ability to vote differently from board recommendations, full disclosure of the implemented program, and the provision of all meeting materials to shareholders, regardless of their participation in the program.
The SEC confirmed the feasibility of implementing this automatic voting program by issuing a no-action letter, which allows interested parties who question the legality of a particular mechanism or action to request the SEC's position on the feasibility of such a mechanism or action.
We examined the automated voting mechanism and its predecessor, broker non-vote, comparing the applicability of automated voting with the realities of the current Russian market and predicting the circumstances under which it might become relevant.
Automatic Voting
Unlike German and Russian companies, the shares of American public companies are often divided among a large number of retail investors. The paper "Exxon's Auto-Voting Plan: Implications for Shareholder Activism and Considerations for Companies" indicates that the average retail shareholder shareholding in large public companies ranges from 15 to 25 percent, but in some cases can reach as high as 40 percent. Retail investors inherently take a passive stance in corporate governance, which, combined with the relatively small group of active shareholders, leads to a redistribution of influence over corporate decision-making: a group of active shareholders can often advance their own initiatives due to the lack of participation of retail shareholders in the company's affairs. Unsurprisingly, such initiatives often favor the interests of this active group of shareholders and run counter to the interests of the company.
The SEC recently confirmed that Exxon, a public company, could implement one option to address the shift in corporate governance toward a minority group of shareholders pursuing their own agendas: automatic voting by retail shareholders in accordance with the board's recommendation. This measure is largely due to the high level of support Exxon's retail shareholders have provided to the board. In its no-action letter, the SEC stated that the following are important conditions for such an automatic voting program:
The program is open to all retail shareholders and provides equal opportunity to join the program;
The program is not available to investment advisers registered under the Investment Advisers Act of 1940 who exercise voting rights with respect to client securities;
Annual reminders of participation in the program and the ability to easily opt out, as well as the ability to change the voting option relative to automatic voting;
Disclosure of information about such a program on the website of the company implementing such a program; and
Provision of all materials to shareholders in preparation for the general meeting of shareholders, despite their participation in the automatic voting program.
The automatic voting mechanism is designed so that retail investors can voluntarily elect to vote automatically in accordance with the board of directors' position at each general shareholders' meeting. Shareholders will also be given the right to choose which issues they will automatically vote on in accordance with the board of directors' position: all issues or only "standard" company matters. To implement automatic voting, retail shareholders may submit a declaration of intent to the company indicating that they will vote in accordance with the board of directors' position. However, such a declaration of intent can be revoked at any time; shareholders will have full access to meeting materials and will be able to cancel any previously submitted automatic votes before the voting concludes and vote for the option they deem correct.
Another automatic voting mechanism previously existed, known as the "broker non-vote." Broker non-vote is a mechanism whereby, in the event of failure to receive a voting instruction from a client, a broker may exercise voting rights on shares held by the shareholder who did not provide the instruction only on "standard" matters related to the company's operations. A broker may not vote on matters classified as "non-standard" without the shareholder's instruction. According to the rules of the New York Stock Exchange, "non-standard" matters are those that could materially affect shareholder rights:
Election of the company's board of directors;
Decision on the company's merger;
The amount of the executive's remuneration.
The practical applicability of an automatic voting mechanism in accordance with the board's position in Russia raises a number of concerns, stemming from the different structure of shareholder capital. Automatic voting is largely aimed at ensuring that shareholders' meetings have the necessary quorum and do not serve as a means for a small group of "active shareholders" (in terms of voting power) to lobby for their interests. In Russian companies, however, share capital is initially controlled by a small group of majority shareholders, who also enjoy broad representation on the board of directors, appointing the majority of the board of directors.
It appears that due to the specifics of the appointment procedure, board members have close ties to the shareholders who nominated them and will therefore also lobby for the interests of the majority shareholders. Therefore, implementing a program to automate retail shareholder voting loses its purpose, as such voting will not have a significant impact on the decisions of the general meeting of shareholders. Adding to the above argument the costly nature of implementing such a program reinforces the idea that introducing automatic voting programs to Russian public companies is irrelevant.
However, we see significant potential for automatic voting by retail shareholders if the average free float of public companies increases exponentially and a trend emerges toward increasing the number of public company shareholders, leading to a decrease in individual shareholdings. Thus, if there is a shift from the "German tradition" of shareholder distribution to the "Anglo-Saxon" tradition, the implementation of automatic voting will become an important part of the sustainable development of public companies.
No action letter
Let's also consider an interesting tool used in SEC practice: the no action letter. A no action letter is a document containing the SEC's legal position on specific controversial issues of securities market legislation.
Essentially, a person who has doubts about the legality of a mechanism or action can submit a request to the SEC questioning the legality of a particular mechanism or action. After reviewing the request, SEC staff may issue a no action letter containing a description of the mechanism and/or action for which the no action letter is issued and the applicable legal provisions, recommending that SEC staff not take enforcement action against the complainant for implementing the mechanism and/or action specified in the no action letter.
Thus, a no-action letter is somewhat analogous to the official explanations of the Bank of Russia, which are provided in accordance with Bank of Russia Instruction No. 6081-U dated March 3, 2022, "On the Procedure for Preparing Official Explanations of the Bank of Russia." However, it may be aimed not at clarifying legislative provisions, but at approving a specific action or mechanism planned for implementation by a specific entity.
At the same time, no-action letters often do not describe the detailed implementation of the mechanism, but rather establish the general principles that should underlie the relevant mechanism and/or action. In the example above, such principles include openness to all retail investors, gratuitous nature, and so on, thereby leaving some discretion to the applicant regarding the implementation of the mechanism and/or action itself.