Current Reconciliation and Allocation Methodologies Used by Broker-Dealers to Address Imbalances

Because the ownership of individual shares held beneficially is not tracked in the U.S. clearance and settlement system, when imbalances occur, broker-dealers must decide which of their customers will be permitted to vote and how many shares each customer will be permitted to vote. Neither our rules nor SRO rules currently mandate that a reconciliation be performed, or the use of a particular reconciliation or allocation methodology. Broker-dealers have developed a number of different approaches as to how votes are “allocated” among customer accounts.79 We understand that these approaches are often influenced by whether the broker-dealers’ customers are primarily retail or institutional investors.

Most broker-dealers have adopted a reconciliation method to balance the

aggregate number of shares they are entitled to vote with the aggregate number of shares

For more information on proxy processing and broker-dealer’s reconciliation and allocation processes, see “Briefing Paper: Roundtable on Proxy Voting Mechanics,” (May 24, 2007), available at http://www.sec.gov/spotlight/proxyprocess/proxyvotingbrief.htm (“Roundtable Briefing Paper”), or “Unofficial Transcript of the Roundtable Discussion on Proxy Voting Mechanics,” (May 24, 2007), available at

http://www.sec.gov/news/openmeetings/2007/openmtg_trans052407.pdf (“Roundtable Transcript”). The term “allocation” refers to the process by which a broker-dealer determines which of its customers will be allowed to vote and how many shares will be allotted to each of those customers.

credited to customer and proprietary accounts.80 The primary reconciliation methods are: (1) pre-mailing reconciliation (“pre-reconciliation”); (2) post-mailing reconciliation (“post-reconciliation”); and (3) a hybrid form of the pre-reconciliation and post- reconciliation methods.81 These methods are described in more detail below. If the broker-dealer finds that it is holding fewer shares at DTC than it has credited to customer and proprietary accounts, it may choose to give up its own votes, as represented by shares credited to its proprietary accounts, by allocating some or all of those votes to its

customers, or it may choose to allocate to its customers only the voting rights attributable to customer accounts.

a. Pre-Reconciliation Method

A broker-dealer using the pre-reconciliation method compares the number of shares it holds in aggregate at DTC and elsewhere with its aggregate customer account position before it sends VIFs to its customers.82 If the aggregate number of shares it holds is less than the number of shares the broker-dealer has credited to its customer accounts, then the broker-dealer will determine which of its customers will be permitted to vote and how many votes will be allocated to each of those customers. Broker-dealers using the pre-reconciliation method request voting instructions from their customers with respect to only those customer positions to which votes have been allocated. We

understand that most broker-dealers give customers with fully-paid securities and excess margin securities first priority in the distribution of votes. It is also our understanding

80

Not all broker-dealers have developed policies and procedures to address the reconciliation and allocation of votes among their customers because historically broker-dealers have usually had enough shares on deposit at DTC to provide a vote to all customers wanting to vote.

81

Roundtable Transcript, note 79, above. 82

that broker-dealers using the pre-reconciliation method tend to have more institutional customers than retail customers.83

Broker-dealers using the pre-reconciliation method have indicated that this method ensures that the votes customers cast will be counted.84 On the other hand, given that some broker-dealers have estimated that only 20% to 30% of their retail customers usually vote, some believe that pre-reconciliation may result in an “under-vote” because investors allocated the ability to vote may not do so, and other investors who do vote may be allocated a number of votes fewer than the number of shares they beneficially own. In addition, some broker-dealers have indicated that the pre-reconciliation method is more expensive than the post-reconciliation method because post-reconciliation only needs to be performed when a broker-dealer receives voting instructions in excess of the number of shares that it holds.

b. Post-Reconciliation Method

A broker-dealer using the post-reconciliation method compares its aggregate position at DTC and elsewhere85 with its actual aggregate customer account position only after receiving VIFs from its customers. Broker-dealers using the post-reconciliation method request voting instructions from their customers with respect to all shares credited to their customer accounts, including for those shares that may have been

purchased on margin, loaned to another entity, or not received because of a fail to deliver.

83

Id. 84

Id. 85

The aggregate number of shares the broker-dealer is entitled to vote may constitute more than just its position on deposit at DTC. For example, the broker-dealer may have additional securities on deposit at a foreign depository or in certificated form.

We understand that broker-dealers using the post-reconciliation method tend to have primarily retail customers rather than institutional customers.86

In the event that a broker-dealer receives voting instructions from its customers in excess of its aggregate securities position, the broker-dealer adjusts its vote count prior to casting its vote with the issuer. The manner in which the adjustment is made varies among broker-dealers. Some firms simply reduce the number of proprietary position votes cast. Others allocate fewer votes to customers with securities purchased on margin or on loan.

Because of the low level of participation by retail voters, some of the broker- dealers using the post-reconciliation method have indicated to the Commission that the number of over-vote situations is not a significant problem and can be addressed in a number of ways, including, but not limited to, the broker-dealer using its proprietary positions to redress any imbalance. The costs associated with the post-reconciliation method are generally considered to be less than those associated with the pre-

reconciliation method because the broker-dealer does not have to go through the costly process of allocating votes among customers unless its customers remit VIFs for more shares than the broker-dealer is entitled to vote in the aggregate.

c. Hybrid Reconciliation Methods

Some broker-dealers have developed hybrid reconciliation methods that use aspects of both pre- and post-reconciliation methods. For example, in one hybrid reconciliation method, a broker-dealer will allocate votes to all of its customers with fully-paid securities but will also allow each margin account customer to instruct the

Roundtable Transcript, note 79, above. 86

broker-dealer that it would like to vote its shares. The broker-dealer will allocate any shares not needed to cover fully-paid account holders to those margin customers who indicated they wanted to vote, thereby giving these margin customers priority over other margin customers.87