Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis), two of the leading providers of corporate governance research and proxy voting services, have published their updated proxy voting guidelines for 2017. Both companies focused their updates on governance issues, primarily with respect to the election of directors and compensation for both executives and directors.
ISS PROXY VOTING GUIDELINES FOR 2017
The ISS proxy voting guidelines updates are effective for annual meetings on or after February 1, 2017. ISS released updates for the United States as well as the Canadian, European and Asian-Pacific markets, but this alert will focus only on the United States updates.
The most significant updates to the ISS proxy voting guidelines relate to:
- Restrictions on shareholder amendments to bylaws;
- Unilateral bylaw/charter amendments by newly public companies;
- “Overboarded” directors;
- Stock splits and dividends;
- Equity-based compensation and other incentive plans;
- Amending cash and equity plans;
- Shareholder ratification of director pay programs; and Equity plans for non-employee directors.
Shareholders’ Ability to Amend the Bylaws
ISS recommends voting “against” or “withhold” for members of the governance committee if the company’s charter imposes “undue restrictions on shareholders’ ability to amend the bylaws.” These restrictions include an outright prohibition on the submission of binding shareholder proposals or share ownership requirements or time holding requirements in excess of SEC Rule 14a-8, which permits proposals by shareholders to amend the bylaws if the shareholder holds shares valued at over $2,000 or more for one year. ISS views a shareholder’s right to amend the bylaws as “fundamental” (and presumably wants to ensure that a changing shareholder base (i.e., one which did not approve or no longer approves of the restriction) can voice its opposition to such restriction).
Unilateral Bylaw or Charter Amendments by Newly Public Companies
In its revisions for the 2016 proxy season, ISS announced that it would generally recommend voting “against” or “withhold” for individual directors, committee members or the entire board (except, potentially, new nominees) of newly public companies if, prior to or in connection with the initial public offering (IPO), the company or its board adopted a charter or bylaws without shareholder approval in a manner that materially diminished shareholders’ rights or that could adversely impact shareholders. ISS recommended several factors for shareholders to consider, including:
- The company’s or the board's rationale for adopting the provision;
- The provision’s impact on the ability to change the governance structure in the future (e.g., limitations on the shareholders’ right to amend the bylaws or charter or supermajority vote requirements to amend the bylaws or charter);
- The ability of shareholders to hold directors accountable through annual director elections or whether the company has a classified board structure; and
- A public commitment to put the provision to a shareholder vote within three years of the date of the IPO.
For 2017, ISS has adopted two key changes to its recommendation regarding unilateral bylaw and charter amendments. ISS will generally recommend voting “against” or “withhold” for directors if the company has completed an IPO with a multi-class capital structure in which the classes have unequal voting rights. ISS also changed the final factor above (that shareholders will have the opportunity to vote on the provision within three years of the IPO) to a consideration of whether the company has adopted a reasonable sunset provision for the adverse provision and/or problematic capital structure.
Last year, ISS announced that, for meetings on or after February 1, 2017, it will begin recommending a vote "against" or "withhold" for individual directors or CEOs who sit on too many public company boards. ISS provided a one-year transition period to allow affected directors to make changes to their board membership if they so choose. The transition period is now coming to an end. Going forward, ISS will recommend voting “against” or “withhold” for directors who sit on more than five public company boards or for a CEO of a public company who sits on more than two public company boards besides his or her own.
Stock Distributions: Stock Splits and Dividends
ISS currently recommends voting “for” management proposals to increase the common share authorization for a stock split or share divided as long as the increase in authorized shares is equal to or less than the allowable increase calculated in accordance with ISS’s Common Stock Authorization policy. ISS felt a clarification change of “increase in authorized shares” to “effective increase in authorized shares” was necessary because proposals to increase authorized common shares may be tied to the implementation of a planned stock split or stock dividend (where the exact number of new shares to be issued may not be known until a later date).
Compensation: Equity-Based Compensation and Other Incentive Plans
ISS uses three “pillars” as part of an “equity plan scorecard” (EPSC) to evaluate equity-based compensation plans: plan cost, plan features and grant practices. In the EPSC, positive factors may counterbalance negative factors, and vice versa. There are currently four items under the “plan features” pillar, including automatic single-triggered award vesting upon a change in control, discretionary vesting authority, liberal share recycling on various award types and a lack of minimum vesting period for shares granted under the plan. This year, ISS has added dividends payable prior to vesting as a “plan feature.” ISS noted that full points on an EPSC will be awarded if the equity plan expressly prohibits, for all award types, the payment of dividends before the vesting of the underlying award. Furthermore, no points will be earned if the prohibition is only applicable to some, but not all, award types.
Compensation: Amending Cash and Equity Plans
ISS issued an update to clarify its approach for evaluating different types of proposals involving amendments to cash and equity incentive plans. Specifically, the policy was renamed and reorganized to more clearly differentiate the evaluation framework applicable to various types of amendment proposals. For proposals seeking approval for Section 162(m) only, ISS will generally recommend voting “for” if the plan administering committee consists entirely of independent outsiders and “against” if the plan administering committee does not consist entirely of independent outsiders. In addition to reviewing the other cash and equity plans it currently reviews, ISS will review, on a case-by-case basis, plans being presented for the first time after an IPO and proposals being bundled with other material plan amendments.
Director of Compensation: Shareholder Ratification of Director Pay Programs
ISS cited a number of high profile lawsuits regarding excessive non-employee director compensation which have resulted in many companies putting forth advisory proposals seeking shareholder ratification of director pay programs. In response, ISS has implemented a new evaluation framework for voting on non-employee director compensation on a case-by-case basis based on whether the equity plan under which the non-employee director grants are made warrants support and several qualitative factors, including:
- The magnitude of director compensation compared to similar companies;
- The presence of problematic pay practices relating to director compensation;
- Director stock ownership guidelines and holding requirements;
- Equity award vesting schedules;
- The mix of cash and equity-based compensation;
- Meaningful limits on director compensation;
- The availability of retirement benefits or perquisites; and
- The quality of disclosure surrounding director compensation.
Director Compensation: Equity Plans for Non-Employee Directors
Although ISS will continue to evaluate equity compensation plans adopted specifically for non-employee directors on a case-by-case basis, it has expanded the various factors considered when assessing the reasonableness of such plans to include the presence of any egregious plan features (such as an option repricing provision or liberal change in control vesting risk). Furthermore, each of the qualitative factors discussed above in “Director Compensation: Shareholder Ratification of Director Pay Programs” will also be considered in this evaluation.
GLASS LEWIS POLICY GUIDELINES FOR 2017
Glass Lewis updates are generally effective for annual meetings on or after January 1, 2017, and relate to the following areas:
- Director overboarding policy;
- Governance following an IPO or spin-off; and
- Board evaluation and refreshment.
Director Overboarding Policy
Glass Lewis will now generally recommend voting “against” or “withhold” for directors who sit on more than five public company boards or for an executive officer of a public company who sits on more than two public company boards besides his or her own. Glass Lewis will consider the following factors when determining whether a director’s service on an excessive number of boards may limit the ability of the director to devote sufficient time to board duties:
- Size and location of other companies where the director serves on the board;
- The director’s board duties at each of the companies where the director serves;
- Whether the director serves on the board of any large privately held companies;
- The director’s tenure on the boards in question; and
- The director’s attendance record at each of the companies where the director serves.
Glass Lewis also may not recommend voting “against” or “withhold” for certain directors if the company provides sufficient rationale for the director’s continued board service. Such rationale should permit the shareholders to evaluate the scope of the director’s other commitments as well as their contributions to the board, including any specialized knowledge and diversity of skills, perspective and background.
Governance Following an IPO or Spin-Off
Glass Lewis similarly clarified its own corporate governance approach to newly public entities. If it believes the board of a company has approved governing documents that significantly restrict the ability of shareholders to effect change (without shareholder approval), Glass Lewis will consider recommending that shareholders vote against the members of the governance committee or the directors that served at the time of the governing documents’ adoption, depending on the severity of the concern. Specifically, Glass Lewis will review for, among other concerns:
- Anti-takeover mechanisms;
- Supermajority vote requirements; and
- General shareholder rights such as the ability of shareholders to remove directors and call for special meetings.
Board Evaluation and Refreshment
Citing its belief that a robust board evaluation process – one focused on the assessment and alignment of director skills with company strategy – is more effective than solely relying on age or tenure limits, Glass Lewis clarified its approach to board evaluation, succession planning and refreshment. Glass Lewis states a preference for monitoring the board’s overall composition rather than imposing inflexible rules that don’t necessarily correlate with returns or benefits for shareholders, such as age or term limits. However, if a company does impose age or term limits, Glass Lewis will consider recommending shareholders vote against the nominating and/or governance committees if the board waives those limits without sufficient explanation.
If you have questions about ISS and Glass Lewis updates or if you would like to learn more about issues covered in this alert, please contact your Smith Anderson lawyer.
Special thanks to Daniel C. Rowe, contributing writer.