Why doesn’t voting work the way it is supposed to work? It’s complicated. Let’s break it down.
The first big problem is in the fine print of most broker agreements. Here’s an example:
When you click and sign something called a margin agreement with a typical broker, you give them the right to take away your vote. They can do that whenever they like, and they don’t have to tell you. Brokers lend your shares out in exchange for money. It sounds crazy, but it’s very common.
You might be wondering who wants to borrow shares, and for what purpose. The answer is: short sellers. Short sellers bet that the price of a stock will go down. They borrow shares and sell them at the current market price, promising to return the shares later. If the stock price decreases, they can buy the shares and return them to the broker, pocketing the difference between the original sale price and the new lower price.
Now imagine that investor Mina has purchased 100 shares and her broker has lent them out to a short seller. The short seller sells the shares to Tahlia, who is also purchases the shares on margin using a different broker. That broker now lends out those shares to a short seller who sells them to Niara….the story continues.
In reality, there are only 100 shares. But because brokers only keep electronic records of ownership, and don’t actually hold the shares, it appears that each of these people own 100 shares. Dr. Susanne Trimbath, an expert in this area, has coined the phrase “Phantom Shares” to describe the shares that Mina and Tahlia hold in this scenario. Really, only one of them, Niara, the last one in the chain, actually owns 100 shares. But because of the convoluted way voting works, all three of them would receive proxy materials, and all three of them can vote. If they all vote, there will be 300 shares voted, an over-vote of 200 shares.
In the scenario above, because 200 additional votes were cast, everyone’s votes were diluted. If this seems like a contrived scenario, it isn’t. Over-voting is a common feature of shareholder elections. To avoid having to report that a particular director received 120% of the vote, the organizations overseeing these elections require brokers to adjust their vote tallies.
Two popular methods are: 1) proportional reduction - if the broker receives twice the number of eligible votes, then they decrease each investor’s votes by 50%, 2) truncation - the broker picks and chooses which votes to discard. That’s right: when send in your vote, sometimes the broker simply doesn’t count it.
To make matters worse, hedge funds and other institutions can manipulate the acquisition of votes in various ways to tip the scales in corporate elections. Sometimes votes are not accurately counted, favoring large institutions at the expense of small investors. These practices continue today.
The right to vote is important. We have fought wars over this right. But somehow, in the corporate world, we tolerate brokers taking away our votes.
iconik was formed to reclaim the shareholder vote. We reject this flawed system. We don’t use margin agreements to take away your right to vote. We avoid vote dilution through careful accounting, and we shoot for maximum transparency and choice, because we believe our customers deserve to know how their shares are being used. It’s time to demand more from brokers, and together we can lead the way.
© 2022 by Iconik Securities, Inc. ("iconik")
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