What happens to the voting rights on shares when the shares are used in a short sale transaction?

By Investopedia Staff AAA
A:

The registered owner of the security, known as the holder of record, is the investor who retains voting rights. This means the holder of record is entitled to vote on any corporate action that is decided upon by shareholders. (For further reading, see What Are Corporate Actions?) When it comes to short sales, the problem that arises is determining who is the holder of record on the shares being shorted.

To understand the flow of voting rights, it is important to first understand the short sale transaction itself. Shares that are available to be shorted come from three sources: the brokerage firm's inventory, another customer's account, or another brokerage firm. The only shares that can be taken from other customer accounts are those from margin accounts. When opening margin accounts, investors enter an agreement with the brokerage firm that their shares can be loaned out, but they still maintain their position in the security.

The short sale transaction starts with the investor inputting an order to short the shares by calling his or her broker or entering the trade online. The brokerage firm then finds the shares from one of the aforementioned three sources and sells the shares in the market; the proceeds are transferred to the account of the investor going short. The position is then closed out when the investor repurchases the equivalent amount of shares and they are returned to the brokerage firm.

To understand who is the holder of record, and thus who retains the voting rights, you just need to follow the shares. Initially, the shares are held by one of the three sources. Whichever source initially held the shares was also the holder of record. When the shares were used in the short sale transaction, the initial source lost its voting rights as it was no longer the holder of record. Even the margin account customer who holds the shares long will lose his or her voting rights in this situation - this is part of the margin account agreement.

The shares are then sold in the market, and the investor who purchases these shares becomes the holder of record for these shares, thus controlling the voting rights. The investor going short does not get the voting rights. When this investor closes his or her short position, the shares are returned to the brokerage firm, and the voting rights return to the initial owner whose shares were used in the short sale.

(For more information about short sales, read our Short Selling Tutorial. To learn more about voting rights, see Knowing Your Rights As A Shareholder.)

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