Proxy Season: More Work For Less Money?

US broker-dealers and banks responsible for distributing proxy materials to beneficial shareholders might have reason to be unhappy this proxy season.

Not counting all the overtime they will have to do to ensure their “street name” investors receive proxy materials, financial intermediaries might just get paid a lot less to do so.

The Securities and Exchange Commission approved of the new pricing model proposed by the New York Stock Exchange in October 2013. The new fees, effective January 9, mark the first change to proxy distribution fees for street-name shareholders since 2002.

“street name” refers to the name of the financial intermediary which appears as the owner of shares on the books of issuers. Most investors’ shares are held in the street name of their brokerage; therefore, companies have no direct knowledge of the actual beneficial owners of the shares and they are legally required to depend on financial intermediaries to distribute proxy information to their street-name investors. By contrast, investors who hold their shares in their own names are known to the issuers, and are typically serviced by transfer agents who the companies hire to keep the records of registered investors.

Broker-dealer and bank proxy operations specialists contacted by FinOps Report declined to quantify the potential decline in proxy-related revenue, which will affect them for the first time during the busiest proxy mailing time of the year. More than 1,000 US corporations hold their annual meetings between March and June, resulting in plenty of late night and weekend work.

Proxy specialists tell FinOps say they are still crunching the numbers and are in discussions with Broadridge Financial, the world’s largest proxy distribution firm, to understand just what the new fees will mean to their bottom lines.

However, at the very least financial firms concede they will be the hardest hit when it comes to separately managed accounts (SMAs) because that is where the New York Stock Exchange has made the sharpest cuts in compensation. The NYSE, which sets proxy fees with the approval of the SEC, has just eliminated any fees broker-dealers and banks can charge issuers for street-name investors in SMAs with positions of less than five shares. In addition, the “suppression incentive fee” to reward broker-dealers and banks for communicating electronically, rather than mailing out proxy materials — formerly either 25 cents or 50 cents per position in an SMA for investors holding more than five shares — has now been slashed to 16 cents per position.

Broadridge Financial, the world’s largest proxy distribution firm, has estimated issuers will pay US$15 million less in proxy distribution fees for holders of separately managed accounts in 2014 than previously.

Owners of SMAs typically allow their broker-dealers to do the voting for them and don’t want to receive proxy materials. As their name implies, SMAs refer to accounts managed separately for each investor as opposed to mutual funds, which are managed for hundreds or thousands of investors as a pooled group. Among the largest sponsors of SMA programs, cited in industry studies, are Morgan Stanley Smith Barney, BofA Merrill Lynch, UBS, Wells Fargo, and Charles Schwab.

“We are still evaluating the changes and don’t wish to reveal how much they will cost us, but we can confirm our operating margins will be squeezed for SMAs,” says a proxy operations manager at a New York-based broker dealer, in a sentiment echoed by five US broker-dealers contacted by FinOps Report.

Overall, the new fee schedule appears to be lukewarm news for some issuers who have been lobbying for change for several years. The SEC has allowed the NYSE to either reduce some of the fees which corporations must pay financial intermediaries to distribute their proxy materials to street-name shareholders and change other fees to a tiered basis from a flat fee.

Case in point: instead of a 40 cents flat position processing fee for each street-name investor, issuers will now pay on a tiered basis, depending on how many street-name investors the bank or broker-dealer has in their stock. The fees will gradually decline from 50 cents per investor for the first 10,000 to 34 cents for each above 500,000 investors.

When it comes to yet another fee, called an intermediary unit fee, issuers have until now been paying 10 cents per investor for street-name investors with less than 200,000 positions and five cents per investor for those holding 200,000 or more. The new schedule for intermediary unit fees is also tiered, starting at 14 cents per street-name investor and ending at 7 cents per street-name investor. (A full list of the changes can be found on here on the FINRA website.) 

However, the proxy fee changes are only a partial triumph in a longstanding campaign by some issuers and transfer agents to radically revamp the current proxy distribution process, which has been coined “proxy plumbing.” They consistently argue that corporations should be allowed to mail proxy materials to street-name investors directly or through their own distributor. Represented by the Securities Transfer Association, transfer agents have also lobbied hard against banks and broker-dealers being paid for handling proxy materials for street-name shareholders in SMAs on the grounds they don’t really have any operational work to do.

The new pricing schedule does not threaten Broadridge’s dominant position in the outsourced proxy distribution market and still doesn’t allow issuers choice, some issuers complain. The issuers are supported by their transfer agents, who likely would benefit from mailing out proxy materials to street-name investors themselves. Although corporations pay the bills, they are practically compelled to work with Broadridge, if that is who their broker-dealers and banks select to manage the proxy distribution process.

Despite earlier signals that it was considering significant changes in the proxy distribution system, it now appears that the SEC has abandoned that pursuit. Instead, the regulator is concentrating its proxy-reform efforts on reducing the clout proxy advisory firms have on the decisions made by fund managers in annual meetings of the issuers whose securities they hold. Some academics have argued that anywhere from six percent to thirty percent of institutional investors rely blindly on recommendations on votes made proxy advisory firms, who often have conflicts of interest. Naturally, such firms — including Glass Lewis & Co and Institutional Shareholder Services deny they have that much influence or any conflict.

Broadridge estimates that the new proxy fee pricing schedule will result in US corporations spending on average four to six percent less to distribute their proxy mailings to street-name investors in 2015 than they in previous years. However, neither Broadridge nor any of the financial firms contacted by FinOps can directly correlate that cost reduction for issuers to specific revenue reduction for broker-dealers and banks. Broadridge’s competitor Mediant Communications was unavailable by press time to comment on how the new proxy fees would affect its customers, or its rivalry with Broadridge. In early January, the New York-based Mediant announced it won a US$7 million round of funding led by private equity firm Argentum Capital Partners.

In a January 27 communique to investors of American depositary receipts (ADRs), BNY Mellon cites Broadridge’s findings on the potential decline in proxy distribution fees for issuers, but says that its own analysis, as one of the largest sponsors of ADRs, shows that issuers of DRs with fewer than 200,000 street-name shareholders would pay less in proxy distribution fees with the new proxy fee schedule. Those with over 200,000 would pay more. In various scenarios, according to BNY Mellon, issuers could pay up to 20 percent more or up to 20 percent less than previously.

More than 800 broker-dealers and banks outsource the proxy distribution process to Broadridge, which sends issuers the bills on their behalf. Broadridge then reimburses the broker-dealers and banks for what it defines as costs related to their internal administrative work. It is that reimbursement which Broadridge will likely be reducing. As a public firm with hefty overhead and investment needed to handle the necessary operational and mailing task, Broadridge isn’t planning to take the financial hit, so broker-dealers and banks will have to.

Broadridge never discloses the terms of its reimbursement to broker-dealers and banks, which is codified in separate  contracts with each. Although the practice has been widely criticized by stock transfer agents, who have called for a further investigation into what they consider to be rebates, the NYSE has not interfered in the matter.

Broadridge officials would not comment on any changes in contractual agreements with its broker-dealer and bank customers as a result of the NYSE’s new proxy fee schedule. “Brokers, through the Securities Industry and Financial Markets Association (SIFMA), support the fee recommendations, although the PFAC’s recommendation of no cost recovery for managed accounts of five shares or less is regarded as arbitrary,” says Chuck Callan, executive director of regulatory affairs for Broadridge. “Brokers did gain recognition from the NYSE for the strong performance of the proxy system.”

PFAC, short for proxy fee advisory committee, refers to the three-year old committee which was established by the NYSE to come up with a new proxy fee schedule. The schedule it recommended in May 2012 was finally approved by the SEC late last year after repeated delays, reflecting the contentious debate among issuers, their transfer agents, and financial intermediaries.

A February 6 research note published by Avondale Partners about Broadridge’s fiscal 2014 second quarter earnings suggests that Broadridge’s proxy revenues will not be harmed by the reduction in proxy fees. “In the past management has noted an expectation that the majority of the fee amounts would likely be first absorbed by the broker-dealers [in the form of reduced rebates] so they would not expect any material negative impact to absolute dollar earnings,” says the report.

Despite the potential lower fees, broker-dealers and banks do stand to benefit from one new addition to the proxy fee schedule. The SEC wants to encourage financial intermediaries to switch street-name investors from costly hard-copy mail to electronic communications. Therefore, broker-dealers and banks will receive a one-time five-year fee of 99 cents per street-name investor that agrees to use an electric mailbox on their broker or bank’s website to access proxy materials and vote electronically.

It’s a gameplan that not only saves trees, but also offers the SEC a relatively inexpensive way to start counting the number of street-name investors who really don’t need to rely on hard copies of proxy materials and ballots any more. 

However, investors have to be new recruits to electronic voting. Broker-dealers and banks cannot claim the 99 cent fee if an investor has already signed up to receive proxy materials electronically before the 2014 proxy season.

“While we don’t think Broadridge’s portion of the EBIP [enhanced broker internet platform] will be material in the short term, the fee should offset cuts on other proxy fees and encourage broker-dealers to pursue more electronic document delivery,” writes Avondale Partners.