With only mere months to go, the industry is soon to face the introduction of new Form N-PX rules which are to impact securities lending programmes and proxy voting. As the sector prepares to adapt, concerns still revolve around amendments.
On 2 November 2022, the U.S. Securities and Exchange Commission (SEC) adopted amendments to Form N-PX designed to enhance the reporting of proxy votes by registered funds and the reporting of executive compensation (“say-on-pay”) votes by institutional investment managers.
Form N-PX was introduced two decades ago and its basic principle was to inform investors how funds voted shares held on their behalf, also known as voting proxies. The changes have come as a result of investors' concerns surrounding the lack of readily usable information.
The amendments to Form N-PX were first proposed during a commission meeting in which SEC chair Gary Gensler highlighted a number of issues surrounding Form N-PX including excessive length of filings, inconsistent reports on votes of the same matter from fund to fund, vague descriptions of votes and lack of machine-readable format.
The transparency initiative
As market participants digest the amended rules and work to define scope and data requirements, the Risk Management Association (RMA) is assisting its members by publishing a summary of the Form N-PX alterations related to securities lending as well as optional language that can be used in the narrative disclosure of the amended form. Disclosure obligations and proxy voting are highlighted in the RMA’s summary.
Quantitative disclosures of securities lending activity are included in the new amendments to Form N-PX — with disclosure obligations for institutional investment managers applying to those firms that exercise discretion over their securities lending programme.
According to Fran Garritt, RMA director of securities lending and global markets risk, ensuring data integrity will be key, as with any transparency initiative, when approaching the “relatively straightforward” securities lending disclosures within Form N-PX.
In terms of proxy votes, each shareholder meeting in which a fund is eligible to vote, the fund must report the number of shares that were voted and the number of shares that the reporting firm has out on loan that it did not recall. In cases where shares were not returned in time for the fund to vote, the reporting party should enter these shares as “loaned” and not as “recalled”, even if the fund intended to recall the shares for voting purposes.
Form N-PX provides opportunity, in Item 1(0), for the fund to enter additional information on the reporting form indicating that it had intended to vote these shares and had recalled them for the purpose of doing so. In these scenarios, a fund may disclose additional information on Form N-PX (Item 1(0)) to make clear that its intention was to vote and that it recalled the shares in time to do so.
Gensler indicates that these amendments will allow investors to better understand and analyse how their funds and managers are voting on shares held on their behalf. In addition, the newly designed Form N-PX aims to provide investors with more detailed information about proxy votes, create more consistency around how funds describe their proxy votes and structure Form N-PX in a machine-readable format.
Garritt suggests that funds and institutional investment managers will look to their lending agents and custodians to provide data to assist with filings that relate to the reporting of securities lending activity and proxy voting records.
He continues: “In-scope clients are encouraged to discuss the new requirements and available reporting with their lending agents before the new rules go into effect. The availability of meeting agenda items ahead of record date to facilitate the timely recall of securities can be an additional challenge for lenders.”
The SEC understands that the additional disclosures are not intended to impact a fund’s determination on whether to vote or lend. As noted in the final rule amendments:
“...the disclosure requirement is not intended to change the analysis reporting persons may undertake currently as to whether to recall a loaned security, such as by creating pressure for reporting persons to programmatically recall lent shares, or to create a negative implication when a reporting person does not recall a loaned security in any given case. Such determinations are subject to an adviser’s fiduciary duties owed to its clients. If a reporting person believes that leaving securities on loan is in the client’s best interest, the reporting person should leave those securities on loan.”
However, when first proposed in 2021, the RMA voiced concerns for the potential for disruptions in securities lending programmes. Garritt believes that some in-scope lenders may consider changing their lending policies to implement a standing recall instruction for all upcoming proxies as a result of the increased disclosure. “This could reduce market liquidity and negatively impact shareholders by reducing the lending returns achieved by funds,” Garritt warns.
While the SEC recognises the benefits of securities lending to funds and their shareholders, and clarifies that the amendments are only intended to increase transparency and not influence behaviour, Garritt says it remains to be seen whether the new disclosure requirements will result in changes to lending policies by in-scope lenders.
To help mitigate any potential negative implications, the SEC has given funds the option to provide a narrative disclosure on the Form N-PX cover page, as well as on a vote-by-vote basis (Item 1(0)). This additional disclosure can be used to give context to the fund’s proxy voting policy and its securities lending activities.
As described by RMA, regarding the narrative disclosure on Form N-PX, the fund participates in a securities lending programme to generate additional income for the benefit of its underlying shareholders. While the fund forgoes its voting rights while shares are on loan, the fund retains the ability to recall loaned securities at any time. The fund recalls loaned securities if deemed appropriate and in the best interest of its shareholders.
Key considerations
While the amendments aim to enhance the reporting of proxy votes, making it easier for investors to evaluate and compare proxy voting records of mutual funds, exchange-traded funds (ETFs) and other fund entities, will the new rules place the industry in good stead to achieve this objective?
Several lenders have already implemented policies and procedures to aid in the decision to lend or restrict lending a security to vote by proxy. Garritt says that these policies often incorporate a number of factors that weigh the benefit of lending revenue against the value created from voting securities that would otherwise be on loan.
“While RMA is an advocate for transparency,” Garritt states, “we question whether the number of shares loaned and not recalled is a meaningful data point for investors to adequately evaluate and compare proxy voting and lending policies across funds.”
The new rule amendments go into effect with votes starting on 1 July 2023, with the first amended Form N-PX filings due in August of 2024.
RMA understands that the majority of lenders currently have the ability to track and monitor proxy dates and shares on loan, either internally or through a lending agent or vendor. Any additional development for the securities lending disclosures required in amended Form N-PX should be minimal and should not present an issue for the industry, according to Garritt.
He concludes: “It is worth noting that shops will need to balance resources across several other regulatory initiatives impacting our business, including the move to T+1 settlement in the US and Canada in 2024 and the potential finalisation and implementation of SEC proposed rule 10c-1.”
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Image: Fran Garritt 
