Another difficulty that arises in the context of street name ownership is the practice of borrowing shares. The term borrowing is a misnomer. The shares are actually sold with the expectation, indeed, the obligation, to sell back different shares at some specified date in the future. see Marcel Kahan & Edward B. Rock, The Hanging Chads of Corporate Voting, August 13, 2007, at 22 (“The securities ‘loan’ is really a transfer by a seller . . . of full legal title in securities to a buyer . . . “).  An active market exists for borrowing shares, most often in connection with short sellers covering their positions. See Henry T. C. Hu & Bernard Black, The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership, 79 S. Cal. L. Rev. 811 (2006).

Shareholders may authorize the practice, generating additional income from shares.  In some cases, the practice originates from the brokers.  For shares purchased on margin, brokers routinely retain the right to lend shares and keep any fees. Marcel Kahan & Edward B. Rock, The Hanging Chads of Corporate Voting, August 13, 2007, at 24-25 (“The standard margin account agreement between brokers and customers grants the broker the right to ‘lend’ out shares in the account, and to keep the fees for doing so, without notifying the customer.”).

The practice adds liquidity to the market but also raises a number of corporate governance concerns. Shares “lent” before the record date result in a transfer of voting rights to the borrower.  Brokers, on the other hand, often do not reconcile the shift in voting rights, with the result that they attribute voting rights to both the lender and the borrower. The practice can result in overvoting.See Marcel Kahan & Edward B. Rock, The Hanging Chads of Corporate Voting, August 13, 2007, at 25 (“Moreover, it is also standard practice for the broker not to identify from which accounts ‘lent’ shares have been taken.”). Or, as the head of the Division of Market Regulation has noted:

• securities lending may contribute to the overvoting problem as well. Even though the industry-standard lending contract allocates the vote to the borrower, the lender broker may not reconcile its records to reflect it no longer has the vote or loaned securities. As a result, if the loaned securities are not returned on or before record date, both the borrower and the lender may attempt to submit a vote for the same securities.

Alternatively, where the records are reconciled, lenders will lose their voting rights. Particularly when the shares are lent around the record date and affect voting rights, this can have serious consequences. See Marcel Kahan & Edward B. Rock, The Hanging Chads of Corporate Voting, August 13, 2007, at 23 (“If a shareholder ‘lends’ its shares out before the record date, the shareholder is no longer a shareholder as of the record date and is not entitled to vote, whether or not the ‘returned’ shares are received prior to the meeting.”)(footnotes omitted).

The other problem is the potential abuse associated with borrowing. Even short sellers who obtain the vote of borrowed shares are voting on matters where they have no intention of retaining any economic interest in the company. Of course, the same is true for any shareholder owning stock on the record date who sells. These problems have long been inherent in the system of voting that depends upon record dates under state law.

The more active potential for abuse are those who borrow shares just before the record date not to cover short positions but to affect the vote at the shareholder meeting. The extent of this practice is very unclear, with few actual examples having been noted. See Henry T. C. Hu & Bernard Black, The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership, 79 S. Cal. L. Rev. 811 (2006)(citing examples of this occurring overseas). Nonetheless, as shareholder votes grow in importance, it is reasonable to assume that some investors will turn to borrowing to increase the odds of winning the election.

Interestingly, for all of the concern over borrowing, the solutions seem relatively straightforward. For one thing, brokers need to be forced to reconcile their records and limit voting rights to either the lender or the borrower.  The failure to reconcile, particularly if involving shares in margin accounts, allows brokers to retain the fees paid for borrowing without having to make the owners suffer any adverse consequences.  Reconciliation would, in the first instance, prevent double counting. Second, brokers should be required in an unequivocal way to disclose to lenders that voting rights will be lost if shares are lent during a period that covers the record date. Shareholders should have the right to determine that shares cannot be lent on or around the record date.

Third, for some reason, brokers seem to fix the identity of street name owners with the right to vote on the record date set by the issuer.  When shares are borrowed (from street name owners) on the record date, title transfers internally within the broker.  Nonetheless, so long as they are returned by the meeting, there is nothing that prevents the broker from returning the votes to the lender.  State law only cares about the number of record owners and doesn't look to the relationship between the broker and the beneficial owner. See In re: Appraisal of Transkaryotic Therapies, Inc., 2007 Del. Ch. Lexis 57 (Del. Ch. May 2, 2007)(“The law is unequivocal. A corporation need not and should not delve into the intricacies of the relationship between the record holder and the beneficial holder and, instead, must rely on its records as the sole determinant of membership in the context of appraisal.”).

If brokers were required to allow street name owners to vote the returned shares (either by contract or regulation), it would likely reduce the risk of borrowing solely to manipulate voting rights.  In order to have the voting rights, the borrowers would have to hold them through the meeting date.  This would add significant costs to the practice, likely discouraging most from doing so simply to acquire voting rights.  

For more on this topic, take a look at "The Shareholder Communications Rules: An Exercise in Regulatory Utility or Futility?"