Proxy advisory firms Institutional Shareholder Services (ISS) and Glass Lewis recently released voting guideline updates for the 2016 proxy season.1 These guidelines provide insight into what recommendations ISS and Glass Lewis will make to their subscribers. This Client Alert analyzes the guideline updates and provides a practical perspective on their implications for public companies. Addressing potential negative ISS and Glass Lewis voting recommendations is a highly individualized analysis which should not be undertaken without the benefit of experienced counsel. The Womble Carlyle Public Company Advisors Team has extensive experience advising public company boards on the proxy voting guidelines of these advisory firms.
ISS and Glass Lewis Concerned about Director “Overboarding”
In the past, ISS and Glass Lewis expressed concern about directors serving on too many boards. Now, both ISS and Glass Lewis have amended their voting guidelines to address the issue. Beginning in 2017, ISS and Glass Lewis will recommend voting against any non-CEO director who serves on more than a total of five public company boards. For the 2016 proxy season, ISS and Glass Lewis will only note this as a “concern.” For CEO directors, Glass Lewis revised its policy to provide for a maximum number of two boards (i.e., the CEO’s company plus one additional board). The Glass Lewis policy also applies to executive officer directors who are not the CEO.
Directors who are at risk of receiving a negative recommendation should take advantage of the one-year transition period to prioritize their board obligations. Companies should review their directors’ other board obligations on at least an annual basis to determine whether overboarding is a concern.
ISS Specific Guideline Changes
Unilateral Amendments to Governing Documents – Special Rules for New Public Companies
Increasingly, ISS takes a dim view of unilateral board actions affecting shareholder rights. ISS’s current guidelines provide that, subject to the consideration of certain factors, it will generally recommend against (or recommend withhold votes for) directors individually, committee members, or the entire board if the board approves a bylaw or charter amendment without seeking shareholder approval if the amendment materially diminishes shareholders rights or could otherwise adversely affect shareholders. Disfavored unilateral board actions include classifying the board, adopting supermajority voting requirements, and eliminating shareholders’ ability to amend bylaws. With respect to these specific actions, ISS will generally continue to recommend against directors until the amendment is reversed or submitted to a binding shareholder vote.
Beginning in 2016, ISS will use a separate group of factors to evaluate unilateral bylaw or charter amendments that were adopted prior to, or in connection with, the company’s initial public offering (IPO). Without drawing a bright-line test or relying on an exhaustive list of factors, ISS will consider (i) rationale, (ii) the ability of shareholders to change the governance structure in the future, (iii) whether the company has a declassified board and (iv) whether the company has publicly committed to put the provision to a shareholder vote within three years of the IPO. This policy change, while perhaps intended to help new public companies, may have significant potential to prematurely push public companies into a governance profile that diminishes shareholder value because the new public companies cannot predict in advance the success of their business plans and the degree of activist interest. New public companies should carefully consider their particular circumstances, engage with shareholders, and prepare an effective proxy communication in the face of this ISS policy announcement.
The current ISS guidelines provide that ISS will consider the same factors to evaluate shareholder nominees to the board as are used to evaluate directors in contested elections. The revised 2016 guidelines give ISS the flexibility to also consider in its evaluation of shareholder nominees “additional factors which may be relevant, including those that are specific to the company, to the nominee(s) and/or to the nature of the election….”
The issue of shareholder nominees is highly specific, and companies facing proxy access issues should consider their unique circumstances, develop a shareholder engagement strategy, and put forward effective proxy communications to help achieve the best outcomes for their shareholders.
Equity Holding Period Proposals
ISS has broadened the guidelines it uses to evaluate how to vote on shareholder proposals relating to executive equity retention. The broadening of these guidelines has eliminated the use of separate guidelines that ISS previously used for named executive officers and senior executive officers. Among the principal factors that ISS will now consider for these shareholder proposals include the suggested retention percentage/ratio and the duration of the required retention.
Executive Compensation – Problematic Pay Practices for Externally Managed Issuers
Externally managed companies typically do not directly compensate their executives but rather pay fees to external managers, who then compensate the executives. To address what ISS views as deficient (or non-existent) disclosure regarding the compensation of these executives, ISS has revised its guidelines to provide that it will generally vote against say-on-pay proposals by an externally managed company where there is insufficient compensation disclosure. The guideline provides that compensation disclosure is inadequate if it does not permit a reasonable assessment of the pay programs and practices applicable to the externally managed company’s executives. In line with this guideline revision, ISS has added “insufficient executive compensation disclosure by an externally managed issuer” to its list of problematic pay practices.
Environmental and Social Issue Proposals
The new guidelines include revisions to the manner in which ISS evaluates proposals relating to a company’s animal-welfare policies, pharmaceutical-product pricing, and climate change and greenhouse gas emissions. We view these changes as ISS continuing to focus on social issues as a source for assessing companies’ business and reputational risk.
Regarding animal-welfare, ISS would generally recommend voting for shareholder proposals seeking reporting on standards of care. With the latest policy revisions, ISS has now broadened its approach to also consider proposals seeking a report on the company’s animal-related risks, such as inhumane-animal-welfare practices in the supply chain. ISS will now also consider animal-related controversies that the company has experienced as a factor in supporting an animal-welfare proposal.
Again focusing on risk, ISS also revised its pharmaceutical-pricing proposal guidelines to consider the potential for regulatory risk exposure and recent significant controversies, litigation, or fines at a company when evaluating a shareholder proposal requesting a report on the company’s product-pricing and access-to-medicine policies.
Lastly, ISS has updated its evaluation guidelines regarding proposals requesting reports on the impact of climate-change risk on a company’s operations and investments. The revised guidelines clarify that such climate-change risk includes financial, physical, and regulatory risks caused by climate change.
As these guideline changes are largely clarifying changes or the codification of factors that ISS has historically considered in its evaluation of environmental and social-issue proposals, we do not expect these revisions to have a material impact on ISS’s voting recommendations during the 2016 proxy season.
ISS QuickScore 3.0
Most companies rely on their ISS QuickScore to provide a dashboard view of their overall governance and compensation profile against ISS policy standards. ISS has released a slightly updated version of this tool for 2016 called QuickScore 3.0.
Beginning in 2016, ISS’s QuickScore product will track whether companies in the Russell 3000 allow for shareholder proxy access. For companies that permit shareholder proxy access, QuickScore will track (i) the ownership threshold and holding period required to exercise the proxy access right, (ii) the number of shareholders permitted to aggregate their holdings, and (iii) the number or percentage of board seats available for proxy access nominees. Although the “proxy access” component has been given a zero weighting in 2016, it is generally anticipated that the “proxy access” component will be weighted the following year.
Equity Plan Scorecard Updates
ISS’s Equity Plan Scorecard (EPSC) is designed to facilitate deeper consideration of equity incentive programs, which are a critical component in motivating executives and aligning their interests with those of shareholders.
The basic EPSC has not changed, but for companies with annual meetings on or after February 1, 2016, the following changes apply:
- The factors upon which ISS will evaluate the equity plans of Russell 3000 and S&P 500 Companies with less than 3 years of disclosed equity grant data (e.g., recent IPOs, bankruptcy emergent companies, etc.) will no longer include the 3-year average burn rate and plan duration. Maximum pillar scores for this model are as follows:
- Plan Cost: 50
- Plan Features: 35
- Grant Practices: 15
- There will be adjustments to certain ESPC factor scores (although the maximum of 100 total points and the threshold of 53 points to receive a favorable equity plan recommendation (absent egregious factors) are unchanged).
- The evaluation factor “Automatic Single-Trigger Vesting” has been renamed “CIC Vesting.” The following scoring guidelines will apply to this factor:
- A plan will receive full points if (i) it doesn’t accelerate time-based awards upon a change in control, provided that acceleration may be permitted if the awards are not assumed or converted in connection with the change in control and (ii) it terminates outstanding performance-based awards or permits vesting of such awards based on actual performance as of the date of the change in control and/or permits prorated vesting based upon how much time has elapsed since the beginning of the performance period to the date of the change in control;
- A plan will receive no points if it permits either automatic acceleration of time-based awards upon a change in control or payout of a performance based award above certain levels.
- A plan that contains vesting terms upon a change in control other than those provided above will receive half points.
- A plan will receive full points if it has a 36 month holding period after the award is fully vested or until termination of employment. The holding period has been extended from the prior period of 12 months. A plan that continues to have a 12 month holding period will receive half-points.
Glass Lewis Specific Guideline Changes
Conflicting Management and Shareholder Proposals
Glass Lewis has outlined its updated approach for determining its support of conflicting management and shareholder proposals. Among the factors that Glass Lewis will consider include the (i) nature of the underlying issue; (ii) benefit to shareholders from implementation of the proposal; (iii) materiality of the differences between the terms of the shareholder proposal and management proposal; (iv) appropriateness of the provisions in the context of the company’s shareholder base, corporate structure, and other relevant circumstances; and (v) company’s overall governance proposals and its adoption of progressive shareholder rights.
A company with conflicting management and shareholder proposals should consider crafting its shareholder communications with an eye toward addressing each of these factors as articulated by Glass Lewis.
Exclusive Forum Provision Proposals
Similar to the ISS policy’s carve-outs for new public companies, Glass Lewis will end its policy of automatically recommending a vote against the chairman of the nominating and corporate governance (NCG) committee of a company that includes an exclusive forum provision in its charter or bylaws in connection with its IPO. Instead, Glass Lewis will weigh the exclusive forum provision in conjunction with other provisions that Glass Lewis believes might unduly limit shareholder rights (e.g., fee-shifting bylaw provision, classified board, supermajority voting, etc.).
Nominating Committee Performance
Glass Lewis is placing formal importance on director effectiveness and refreshment, seeking to hold the chair of the NCG committee directly responsible. Glass Lewis may recommend voting against the NCG committee chair if the “board’s failure to ensure the board has directors with relevant experience, either through periodic director assessment or board refreshment, has contributed to the company’s poor performance.” This new consideration is among several that Glass Lewis will evaluate when determining whether to recommend a vote against the NCG committee chair. Among other factors that Glass Lewis will consider include whether the nominating committee met during the preceding year, whether there are less than 5 or more than 20 directors on the board and instances in which a director received greater than a 50% against vote during the prior year and the director was not removed, nor was the concern raised by the shareholders with respect to that director addressed.
Companies should consider updating their annual director questionnaires to take account of the Glass Lewis policy considerations and draft effective proxy statements explaining their directors’ qualifications and contributions.
Glass Lewis has revised its guidelines to include additional information regarding its policy on disclosure of one-time and transitional awards. The revised guidelines express Glass Lewis’s belief that transitional arrangements (e.g., sign-on awards) should be clearly disclosed and accompanied by a meaningful explanation of the payments and the process by which the value of the payments were determined. Additionally, details regarding any “make-whole” payments should also be provided, as well as a description of how any one-time award may affect the company’s regular compensation grants.
Environmental and Social Risk Oversight Proposals
Glass Lewis has codified its guidelines regarding the oversight of directors for environmental and social issues, and like ISS, the focus is on risk. The guidelines provide that Glass Lewis may consider a vote against directors where the board or management has “failed to sufficiently identify and manage a material environmental or social risk” that did or could negatively impact shareholder value.
As this guideline change merely involved a codification of a guideline that has already been in use, we do not expect the adoption of this guideline to have much effect on Glass Lewis’s current voting practices.
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1ISS, Americas 2016 Benchmark Policy Recommendations, available at http://www.issgovernance.com/file/policy/2016-americas-policy-updates.pdf (Nov. 20, 2015)