The proxy advisory firms ISS and Glass Lewis, recently announced updates to their respective voting policies for domestic companies for the upcoming 2015 proxy season. These two firms have risen to prominence in recent years, wielding significant power in corporate governance matters, proxy fights and takeover votes. Hedge funds, mutual fund complexes, institutional investors and similar organizations that own shares of multiple companies pay ISS and Glass Lewis to advise them regarding shareholder votes.
The ISS and Glass Lewis policy updates are effective for annual meetings on or after February 1, 2015, and January 1, 2015, respectively. For your convenience, we have summarized below the most important updates relating to corporate governance matters.
Independent Board Chairs
The most notable ISS policy change relates to shareholder proposals that seek to separate the chairman and chief executive officer positions. For the 2015 proxy season, ISS is adding new governance, board leadership and performance factors to its current analytical framework. In this regard, ISS’s policy will continue to generally recommend that shareholders vote “for” independent chair shareholder proposals after consideration in a “holistic manner” of the following factors:
- Scope of the Proposal: Whether the shareholder proposal is binding or merely a recommendation and whether it seeks an immediate change in the chairman role or can be implemented at the next CEO transition.
- Company’s Current Board Leadership Structure: The presence of an executive or non-independent chairman in addition to the CEO, a recent recombination of the role of CEO and chairman, and/or a departure from a structure with an independent chairman.
- Company’s Governance Structure: The overall independence of the board, the independence of key committees, the establishment of governance guidelines, as well as board tenure and its relationship to CEO tenure.
- Company’s Governance Practices: Problematic governance or management issues such as poor compensation practices, material failures of governance and risk oversight, related party transactions or other issues putting director independence at risk will be reviewed as well as corporate or management scandals and actions by management or the board with potential or realized negative impacts on shareholders.
- Company Performance: One-, three- and five-year total shareholder return compared to the company’s peers and the market as a whole.
In view of its new holistic approach in evaluating these types of shareholder proposals, ISS indicates that a “For” or “Against” recommendation will not be determined by any single factor, but that it will consider all positive and negative aspects of the company based on the new expanded list of factors when assessing these proposals.
Glass Lewis generally does not recommend that shareholders vote against CEOs who also serve as chairman of the board of directors, but it encourages clients to support separating the roles of chairman and CEO whenever the issue arises in a proxy statement.
Unilateral Bylaw/Charter Amendments
ISS and Glass Lewis have adopted new policies pursuant to which they will generally issue negative vote recommendations against directors if the board amends the bylaws or charter without shareholder approval in a manner that materially diminishes shareholder rights or otherwise impedes shareholder ability to exercise their rights (“Unilateral Amendments”).
Under the updated policy, if the board adopts a Unilateral Amendment, ISS will generally make a recommendation for an “against” or “withhold” vote on a director individually, the members of a board committee or the entire board (other than new nominees on a case-by-case basis), after considering the following nine factors, as applicable:
- the board’s rationale for adopting the Unilateral Amendment;
- disclosure by the issuer of any significant engagement with shareholders regarding the Unilateral Amendment;
- the level of impairment of shareholders’ rights caused by the Unilateral Amendment;
- the board’s track record with regard to unilateral board action on bylaw and charter amendments and other entrenchment provisions;
- the issuer’s ownership structure;
- the issuer’s existing governance provisions;
- whether the Unilateral Amendment was made prior to or in connection with the issuer’s IPO;
- the timing of the Unilateral Amendment in connection with a significant business development; and
- other factors, as deemed appropriate, that may be relevant to the determination of the impact of the Unilateral Amendment on shareholders.
Glass Lewis has revised its policy to provide that, depending on the circumstances, it will recommend that shareholders vote “against” the chairman of the board’s governance committee, or the entire committee, in instances where a board has amended the company’s governing documents, without shareholder approval, to “reduce or remove important shareholder rights, or to otherwise impede the ability of shareholders to exercise such right” such as:
- the elimination of the ability of shareholders to call a special meeting or to act by written consent;
- an increase to the ownership threshold required by shareholders to call a special meeting;
- an increase to vote requirements for charter or bylaw amendments;
- the adoption of provisions that limit the ability of shareholders to pursue full legal recourse (e.g., bylaws that require arbitration of shareholder claims or “fee-shifting” bylaws);
- the adoption of a classified board structure; and
- the elimination of the ability of shareholders to remove a director without cause.
Equity Plan Proposals
Of particular importance to management are the revised ISS and Glass Lewis policies pertaining to their voting recommendations on company proposals seeking shareholder approval of equity compensation plans. Equity compensation of management remains a central focus of many institutional investors and shareholder activists.
For 2015, ISS adopted a new “scorecard” model, referred to as Equity Plan Scorecard (“EPSC”), that considers a range of positive and negative factors in evaluating equity incentive plan proposals, rather than the current six pass/fail tests focused on cost and certain egregious practices to evaluate such proposals. The total EPSC score will generally determine whether ISS recommends “for” or “against” the proposal.
Under its new policy, ISS will evaluate equity-based compensation plans on a case-by-case basis depending on a combination of certain plan features and equity grant practices, as evaluated by the EPSC factors. The EPSC factors will fall under the following three categories (“EPSC Pillars”):
- Plan Cost (45 percent weighting): The total estimated cost of the company’s equity plans relative to industry/market cap peers. ISS will measure plan cost by using ISS’s Value Transfer Model (SVT) for the company in relation to its peers. The SVT calculation assesses the amount of shareholders’ equity flowing out of the company to employees and directors.
- Plan Features (20 percent weighting): The presence or absence of provisions in the plan providing for (i) automatic single-triggered award vesting upon a change in control; (ii) discretionary vesting authority; (iii) liberal share recycling on various award types; and (iv) minimum vesting period for grants made under the plan.
- Grant Practices (35 percent weighting): The issuer’s recent grant practices under the proposed plan and all other plans including (i) the company’s three-year burn rate relative to its industry/market cap peers; (ii) vesting requirements in most recent CEO equity grants (three-year lookback); (iii) the estimated duration of the plan based on the sum of shares remaining available and the new shares requested, divided by the average annual shares granted in the prior three years; (iv) the proportion of the CEO’s most recent equity grants/awards subject to performance conditions; (v) whether the company maintains a clawback policy; and (vi) whether the company has established post exercise/vesting share-holding requirements.
In its updated voting policy, ISS will generally recommend voting “against” the plan proposal if the combination of the factors listed above in the EPSC Pillars indicates that the plan is not, overall, in the shareholders’ interests, or if any of the following apply:
- awards may vest in connection with a liberal change-of-control definition;
- the plan would permit repricing or cash buyout of underwater options without shareholder approval (either by expressly permitting it – for NYSE and Nasdaq listed companies – or by not prohibiting it when the company has a history of prepricing – for non-listed companies);
- the plan is a vehicle for “problematic pay practices” or a “pay-for-performance disconnect;” or
- any other plan features are determined to have a “significant negative impact on shareholder interests.”
In recent years, many issuers have received shareholder proposals seeking reports or other disclosure regarding political contributions, including lobbying and political activities. Under the updated policy on political contribution shareholder proposals, ISS will generally recommend that shareholders vote “for” proposals requesting greater disclosure of a company’s political contributions and trade association spending policies and activities, after considering:
- the company’s policies as well as management and board oversight related to its direct political contributions and payments to trade associations or other groups that may be used for political purposes;
- the company’s disclosure regarding its support of, and participation in, trade associations or other groups where it makes political contributions; and
- recent significant controversies, fines or litigation related to the company’s political contributions or political activities.
Despite the policy changes discussed above, public companies should continue to tailor their individual governance policies with a view towards what is in the long-term best interests of their own shareholders as opposed to meeting the ISS and Glass Lewis guidelines. ISS notes that its 2015 policy is intended to address the recent substantial increase in bylaw/charter amendments that adversely impact shareholder rights without being subject to a shareholder vote. Companies that intend to adopt any corporate governance policies that adversely impact shareholder rights should consider seeking shareholder support before implementing such policies, if a negative ISS or Glass Lewis recommendation on re-election of directors is likely to have a material effect on the election.
Companies should review last year’s proxy compensation and governance disclosures in order to make improvements in this year’s disclosures where appropriate – particularly if the company has received comments on this disclosure from the SEC staff. The failure to address a previous year’s staff comment may provoke a more detailed review by the staff, with its attendant time delays, should it be noticed during the staff’s initial screening of the filing.
Companies should also review their corporate governance and compensation practices for potential vulnerabilities under ISS’ policy updates, such as equity compensation plans that may be up for a vote at the next annual meeting or an independent chair shareholder proposal, and decide what action, if any, to take in light of this assessment.
Companies should continue a regular dialogue with key investors, bearing in mind limitations imposed by the SEC on proxy solicitations. Shareholder engagement efforts should continue to focus on what shareholders’ greatest concerns are and the rationale for board action.