To: Rule Comments
Dear Mr. Katz,
The subject of this proposed rule is proxy voting. The topic addressed is the current costs associated with the dissemination of proxy material. The proposed solution, which we are asked to consider, is the allowance of an internet-based proxy distribution model.
There are underlying systemic flaws in our indirect holding system which affect proxy-related costs: When the number of securities entitlements exceeds the total number of shares outstanding for an issuer, and especially when the number of excess entitlements is greater than the total number of shares that can legally be encumbered, the economic costs to companies and shareholders can be substantial. The current fungible nature of trading within the indirect holding system, and the lack of an audit-trail sufficient to identify potential inequities (or those affected) make it [a] possible to create securities interests that are not, and cannot be, affirmatively collateralized by an unencumbered share (technically creating a non-voting interest), and [b] impossible to identify and notify the affected purchasers. Among the many deleterious consequences of such conditions are rampant over-voting and/or the dissemination of proxy materials to more shares than the issuer has outstanding.
For all shares held indirectly, please consider the incorporation of the following distinction between securities entitlements:
1) Secured Entitlement: The last purchaser in an entitlement chain holds a “secured entitlement” if the highest-tier securities intermediary in the chain possesses the security directly (as evidenced by the master shareholder list of the issuer), and where no other legal encumbrances exist against the security.
2) Unsecured Entitlement: The last purchaser in an entitlement chain holds an “unsecured entitlement” if the highest-tier securities intermediary in the chain does not possess the security directly (for example, if the 'buy-in' of a secured entitlement would be required, in order to satisfy the Article 8 obligations of any securities intermediary in the entitlement chain, then the entitlement is unsecured). Unsecured entitlements would include [a] entitlements held by the client of a lender in a short-sale transaction, [b] entitlements held by the last-purchaser of an open fail-to-deliver, [c] any other entitlements orginating from a securities interest created for the purpose of facilitating the disposition of securities and/or financing any settlement obligation, and/or [d] any other entitlements originating from a credit for delivery against an open position.
Please consider the following comments, as they relate to the entitlement distinction defined above, and to the costs relative to proxy-related matters:
For all shares held indirectly, only holders of secured entitlements should have the right to proxy. This seems a logical and direct course for assigning proxy rights within an indirect holding system. Expressly limiting proxy rights to direct holders of securities, and holders of secured entitlements, would prevent the excess dissemination of proxy materials, and eliminate any possibility of over-voting.
Securities intermediaries should, at all times, maintain the records necessary to identify the secured or unsecured nature of their obligation to each entitlement holder. The last-purchaser of an unsecured entitlement, or a lowest-teir secured entitlement holder whose entitlement becomes unsecured through the actions of a securities intermediary, should be notified immediately of the unsecured nature of their entitlement and the resulting limitations of holding such a financial asset. At any time after notification, and upon order of the unsecured entitlement holder, the securities intermediary should be obligated to immediately buy-in a 'secured entitlement position', to reconcile the unsecured nature of the position, unless otherwise expressly agreed to by the lowest-tier entitlement holder. These actions are necessary to ensure that securities intermediaries remain in compliance with the provisions of (at minimum) the ’34 Act Section 17Aa.1.A, Rule 15c6-1a, and Rule 15c3-3a.1.
The aggregate number of lowest-tier unsecured entitlements in each security should be published daily. Issuers and investors cannot otherwise make informed decisions.
Implementation of such rules would require that securities intermediaries, individually and cumulatively, properly audit the nature and status of each entitlement, for every security; aggregate entitlement data should be maintained by the DTCC, and published daily, with strict oversight and enforcement by NASD and SEC.
The proposed rule [34-52926] correctly identifies the importance of “taking advantage of technological developments and the growth of the Internet and electronic communications.” I would further request that the suggested changes mentioned above be effectuated, noting that the current state of “technological developments and the growth of the Internet and electronic communications” make implementation of these rule-changes possible, without significantly altering the indirect holding system, or the current fungible trading environment. Though the proposed rule is narrow, we must address the underlying issues, the effects of which are evidenced through the perversion of proxy rights. To neglect the broader proxy issues at this time would be, in effect, the economic equivalent of stepping over dollars to pick up dimes.