The upcoming Woolworths’ Annual General Meeting (AGM) will be interesting from a number of angles.
First, the WOW Board will be under immense pressure to justify why they should hold their positions and the Remuneration Report could be voted down by shareholders. The other interesting angle will be to analyse the level of shareholder voting to try and determine if Australia’s largest superannuation fund managers vote all their shares at the AGM.
Unfortunately it will be hard to determine who is voting. The great bulk of market participants utilise custodians or nominees to hold their stock positions. Many large funds will not clarify the situation as they will not be advising the market (or even their members) of their voting intentions. It will be another example of how the Australian share market operates in a continual state of smog and rumour.
Today, the biggest road block for major funds in voting at the WOW AGM is the high level of WOW stock lending that has been undertaken prior to this meeting. Today WOW has about 9.5% of its voting shares sold short and a fair slab of these shares have probably been lent by the largest funds that have a fiduciary relationship with their clients.
Just how many WOW are lent by Australian funds? Well that is not properly disclosed. We note the constant movements of stock inside substantial notices from Custodians. However, these disclosures of lending arrangements are cloaked inside ownership notices and many are simply incomprehensible.
Major fund managers including Industry Funds defend their lending activity by claiming that:

  1. The activity generates small fees that benefit their member returns; and
  2. The lent shares can be called back within 24 hours in advance of an AGM in order that they can vote on behalf of members.

The problem with the second assertion above is that there is no overt evidence that the funds call back their lent securities to vote. Just last week, Flight Centre held an AGM. A week before the meeting, it was 13.9% short and on the day of the AGM it was still 13.1% short. Based on that observation it would suggest that none of the shares that are lent in Flight Centre come from the biggest owners of stock in Australia who voted at the AGM.
That leads to the following questions – where do the lent shares come from and is it possible that stock that is lent can still by some arrangement be voted?
Woolworths’ AGM under the microscope
Now let’s be very clear in the case of WOW. If there was any risk that a slab of its 9.5% would be called back by lenders to vote, then the stock would be rocketing upwards. With over $3 billion (yes $3 billion!) of the stock short sold, there is absolutely no way that the stock could be covered before the meeting in 5 trading days. The $3 billion of shorted stock is owned by funds run by managers in Australia and overseas on behalf of clients who are justified to believe that their voting rights as a WOW’s shareholder are being protected.
So why are the “shorts” so comfortable and not being compelled to cover going into the WOW AGM?  Frankly we do not know, but it deserves an investigation as it suggests that a “covert” arrangement regarding voting is in place between the three parties to a lending agreement. These are the lender, the borrower and the facilitator or middle man.
So who is the middleman in this arrangement? Well many of the funds undertake their securities lending through their custodian. Importantly, the arrangement with the custodian is often governed by a contract through which the fund actually lends the stock to the custodian who then facilitates the lending.
An essential part of a custodial arrangement is that the custodian must vote the lent shares if directed. Therefore, if the custodian has not got the votes then they must close their lending arrangement with borrowers who have borrowed and sold short sold the stock.
The custodian must vote shares under their control as directed but one wonders as to how they monitor all the votes, the lending arrangements and the instructions covering hundreds of millions of shares from multiple parties. In any case it would seem to be good business practice for a custodian to absolutely be on top of their voting instructions and capability well before the actual vote.
Fundamental Questions
We again pose the fundamental question for it affects Australia’s largest fund managers and corporate governance in this country –  If the largest fund managers including Industry Funds are all going to vote all their shares at the WOW AGM (given that Industry Funds commonly adopt best practice corporate governance principles) then why is WOW stock not being covered and covered quickly? Surely the lenders cannot vote shares they have lent?
There is a further and important issue that needs to be addressed by all the large lenders of stock. It seems to us that when funds lend shares to parties to short sell they should be aware of the fiduciary duty they owe to their members. In particular they should be cognisant of the amount of stock that they are lending, either alone or with other parties. The provision of a substantial amount of stock can disrupt the proper functioning of markets and therefore price. There have in our view been numerous examples of this over the last few years. For instance we have noted at various times excessive lending and therefore excessive shorting of Cochlear, JB Hi Fi and the Reject Shop. Today WOW may be a case in point.
Our view is that the lending of an excessive amount of stock that unbalances the market and drives down the market price cannot be in the interest of the underlying owners of a stock unless they wish to buy it. However, if a lower price is desired by a lender so it can undertake purchasing then price manipulation would occur and that is arguably illegal.
We believe that a rational regulatory response would be to put limits on the amount of stock that can be shorted in any particular security at any point. We do not suggest that shorting be banned but we do observe that lenders do not perceive what a fair limit is and so regulation is required.
What is a fair or reasonable limit? That is a discussion worth having but surely it should be a function of the liquidity of the stock based on its trading history observing average or normal trading volume. Without such rules then serious issues can result and not only issues regarding excessive price volatility or price manipulation but also corporate governance – and that brings us back to the WOW AGM next week where maybe we may gain an insight into what really is happening in the WOW market.
View Notice of Woolworths AGM