Shareholder Communications and the Problem of Street Name Ownership (Part 1)

We begin today with a multi-part discussion of the problems associated with communicating with street name owners, those shareholders who hold stock through brokers or banks.  They account for the vast majority of those holding stock in public companies, with recent estimates placing the percentage of shares of public companies held by beneficial owners at around 85%.  Street name ownership eliminates the stock certificate from the transfer process, with transactions reflected through book entry.  Largely implemented after the "paperwork crisis " of 1971 (for more history, see Shareholder Communication Rules, at 720), the use of street name accounts has greatly facilitated a liquid trading market. 

At the same time, it obscures the true identity of shareholders from the company, making communication far more difficult.  The street name shares are owned by the broker or bank.  They in turn place the shares with the Depository Trust Corporation, or DTC.  DTC in turn holds them through a nominee, Cede & Co.  Thus, unlocking the identity of the street name owner requires a system that first must look through the depository to the brokers and banks depositing shares, then through the broker or bank to the ultimate owners. 

The process is complicated by a plethora of regulators.  It is state law that determines who gets to vote shares.  In general, the right falls to record owners.  Because the record owner for street name shares is usually Cede & Co., it is the depository that has the voting rights under state law.  This is, of course, an anomalous result.  DTC has no economic interest in the shares, merely holding them for safekeeping.  As a result, a complicated system has arisen for transferring voting rights from depositories to brokers to street name owners.

Although state law regulates voting rights, the rules of the stock exchanges govern much of the behavior of brokers in connection with the shares held by street name owners.  Of particular note, Rule 452 addresses voting rights of shares held by street name owners.  Consistent with the rule, brokers ordinarily send voting instructions to street name owners and must vote the shares as instructed.  A high percentage of street name owners do not return the instructions.  In those circumstances, the brokers may vote the shares, but only for uncontroversial matters.  This includes uncontested elections for directors.  In an era of majority vote requirements and "just say no" campaigns, this authority has come under increasing challenges. 

Finally, the Commission has in place the Shareholder Communication Rules, mostly Rule 14a-13 (imposing obligations on issuers), Rule 14b-1 (imposing obligations on brokers) and Rule 14b-2 (imposing obligations on banks). The rules are extraordinarily long and ensconce in stone the system of communication that requires companies to deliver materials to brokers and banks for forwarding to beneficial owners.  The system is circuitous, expensive and time consuming.  It likely results in regular non-delivery of material.  In short, it is a disaster.  The rules further provide that issuers can request from broker and banks a list of beneficial owners (the so called NOBO list) but have adopted a regulatory regime that makes this almost useless.

Over the next week or so we will explore these topics in greater detail.  They will included the system of communicating, the problems of NOBO lists, the issues surrounding the borrowing of shares, and the problems associated with over voting, which is the problem of brokers voting more street name shares than they actually own.

For more on this topic, take a look at "The Shareholder Communications Rules:  An Exercise in Regulatory Utility or Futility?"   It contains a thorough discussion of the system of communicating with street name owners and a critique of the shareholder communication rules. 

Comments

[Bret Hendzel]

Through conventional means available to public corporations, it appears that there is little chance to acquire a complete list of all of its shareholders, particulary those under "street name" and registered in the nominee designated as "Cede & Co".

It is hard to fathom that the entity that facilitates all electronic transfers,the DTCC and its multiple subsidiaries, does not have the capacity to provide a list of "all" owners in a particular security.

Is a truly complete shareholder list (not just brokerage house share counts) something the DTCC could actually compile and provide if it were via court order?