New Factors for U.S. Companies Relate to Proxy Access, Board Refreshment and Exclusive Forum Provisions; Data Verification Period Open Until November 11

SUMMARY

Earlier this week, Institutional Shareholder Services released the details of its updated "QualityScore" corporate governance rating system, previously named the "QuickScore" rating system.

Through 8 p.m. eastern time on November 11, companies may access the underlying data that ISS will use to construct their QualityScore rating through ISS's website. New scores will then be released on November 21 and begin appearing in ISS research reports.

Because some institutional shareholders may rely, in part, on a company's corporate governance ratings to make voting and investment decisions, companies may want to consider taking steps to ensure that the information on which these ratings are based is accurate. Information on QualityScore, including the technical document and information on data verification, is available on ISS's website at http://www.issgovernance.com/solutions/iss-analytics/qualityscore/.

BACKGROUND

In 2013, ISS introduced a new corporate governance metric, referred to as ISS Governance QuickScore. This system provides each covered company with a risk score, from 1 to 10, in each of four governancerelated categories or "pillars": Board Structure; Compensation/Remuneration; Shareholder Rights & Takeover Defenses; and Audit & Risk Oversight, as well as an overall governance risk score. The scoring is such that "1" means higher quality and lower governance risk, and "10" means lower quality and higher governance risk. The score is based on dozens of factors relating to governance structure. QuickScore, which has now been renamed QualityScore, is a relative measure, with the score indicating a company's rank relative to other covered companies in its market index and/or geographic region. The weighting of the factors is not fixed but is based on an undisclosed formula measuring each factor's correlation with various financial metrics. The scores are included in ISS's proxy analyses and are made publicly available through Yahoo! Finance and Bloomberg.

NEW AND AMENDED FACTORS FOR U.S. COMPANIES

For the updated QualityScore system, ISS has made a number of changes from the prior QuickScore factors. Annex A lists the updated factors for U.S. companies, marked to show changes from those included in the October 2015 update.

Board Structure Pillar. The following new factors have been added:

  • "What is the proportion of women on the board?" This factor was previously incorporated in a single factor addressing both the number and proportion of women on the board. Now it is separate, meaning there are two distinct factors addressing women's representation on the board of directors (one that addresses absolute number and the other that addresses proportion).
  • "What proportion of non-executive directors has been on the board for less than 6 years?" and "Does the board have any mechanisms to encourage director refreshment?" These two new factors were added to the analysis of board refreshment. The first factor awards increasing credit for increasing proportions of the board represented by directors with less than six years of tenure, but gives no additional credit once such proportion exceeds one-third and does not count executive directors. The second factor has a zero-weight impact on the QualityScore and has been added for informational purposes only. ISS specifies mandatory retirement age and term limits as examples of mechanisms to encourage director refreshment.
  • "Does the company disclose the existence of a formal CEO and key executive officers succession plan?" ISS will consider whether a company has disclosed a board-approved, periodically evaluated succession plan for the CEO, other senior management and key effective officers.
  • "Has ISS' review found that . . . the company has had other governance failures?" This is new language added to the existing factor assessing whether the board has taken unilateral action that materially reduces shareholder rights. ISS states that governance failures include "material failures of governance, stewardship, risk oversight or fiduciary responsibilities at the company; failure to replace management as appropriate; or egregious actions related to a director's service on other boards that raise substantial doubt about his or her ability to effectively oversee management and serve the best interests of shareholders at any company." According to ISS, the most common categories of governance failures are excessive pledging of shares and failure to opt-out of state laws requiring a classified board (Indiana and Iowa).
  • "Has the board adequately responded to low support for a management proposal?" ISS specifically focuses on director elections, the say-on-pay vote and the frequency of the say-on-pay vote. ISS considers less than 50% of the votes cast to be low support for director elections and less than 70% of the votes cast low support for say-on-pay votes. With respect to say-on-pay frequency, ISS examines adoption of a say-on-pay frequency that received lower support than the frequency preferred by a majority or plurality of shareholders.

Compensation/Remuneration Pillar. The following new factor has been added:

  • "Does the company employ at least one metric that compares its performance to a benchmark or peer group (relative performance)?" This factor considers whether there is a pre-established metric, in any short-term or long-term incentive plan, that is set or measured relative to an external group, such as a peer group, an index or competitors.

Audit & Risk Oversight Pillar. The following new factor has been added:

  • "What is the tenure of the external auditor?" This factor has a zero-weight impact on the QualityScore and has been added for informational purposes only.

Shareholder Rights & Takeover Defenses Pillar. The following new factors have been added:

  • Three new factors have been added that relate to shareholders' litigation rights. ISS notes that limitations on shareholders' litigation rights continue to proliferate and that as other types of limitations emerge, they will be captured.

o "Does the company have an exclusive venue/forum provision?"

o "Does the company have a fee shifting provision?"

o "Does the company have a representative claim limitation or other significant litigation rights limitations?"

  • Four new factors have been added related to proxy access bylaws. The existence of a proxy access right was previously included as a "zero weight" factor. It is now a weighted factor, and the following additional related factors have been added by ISS.

o "What is the ownership threshold for proxy access?" ISS notes that most companies have adopted 3% of the voting power as the threshold, as favored by investors.

o "What is the ownership duration threshold for proxy access?" ISS notes three years of ownership has found acceptance among investors and companies, and that longer holding period requirements are considered excessive.

o "What is the cap on shareholder nominees to fill board seats from proxy access?" ISS notes that investors have generally approved a range of 20% to 25% of the board, and that many companies have adopted a "greater of 2 persons or 20%" standard.

o "What is the aggregation limit on shareholders to form a nominating group for proxy access?" ISS notes that a limitation of no fewer than 20 shareholders has generally been considered a minimal restriction.

  • "Are all directors elected annually?" This question is unchanged, but the commentary following the question now notes that it includes the consideration of whether a company, though currently elected annually, could classify its board without shareholder approval.
  • "Does the company require a super-majority vote to approve amendments to the charter and bylaws?" This question is unchanged, but the commentary following the question now notes that it includes the consideration of whether shareholders have the right to amend the bylaws.
  • "Can the board materially modify the company's capital structure without shareholder approval?" ISS notes that companies generally are required to put authorized capital increases or reductions to a shareholder vote, but that Maryland-incorporated REITs have the ability to increase or decrease authorized capital without a shareholder vote unless they opt in with a specific charter provision.