Institutional Shareholder Services Inc. (“ISS”) recently released the results of its Policy Survey (the “Survey”) for 2015-2016. The Survey provides insight each year into (a) the most important current issues to institutional investors, issuers and other corporate governance stakeholders and (b) possible amendments by ISS to its Proxy Voting Guidelines for the forthcoming proxy season.  After reviewing the results of the Survey, ISS typically releases proposed changes to its Guidelines in late October, followed by an open comment period, and releases the final Update in November.  Although we disagree with some of ISS’s proxy voting policies, we commend ISS for soliciting the views of market participants each year.

This year, ISS received 421 responses to its Survey, including responses from 114 institutional investors and 257 corporate issuers. Nearly 70% of investor respondents (“Investors”) had assets of more than $1 billion, and almost 30% of Investors had assets of more than $100 billion. Some of the Survey results are particularly important for publicly traded Maryland companies, especially real estate investment trusts (“REITs”), because they relate to Maryland law or to REIT operations. Included below are selected results from the Survey that we think may be most significant to Maryland public companies.

Externally Managed Entities: The Survey sought feedback regarding externally managed entities that provide minimal disclosure for Say-On-Pay votes because the entity’s operations, including compensation of officers, are conducted through the manager. Seventy-one percent of Investors stated that, in such situations, ISS should recommend against the Say-On-Pay proposal and another 13% of Investors stated that ISS should recommend an abstention. As is well known, ISS’s recommendations on Say-On-Pay proposals are very influential; indeed, our most recent experience has been that, absent other issues, institutional holders tend to link their votes on director re-election to their views on the company’s executive compensation. Potential recommendations against the Say-On-Pay proposal by ISS would almost certainly motivate externally managed entities to include greater compensation disclosure in their proxy statements.

Use of Adjusted Metrics in Incentive Programs: The Survey asked respondents to weigh in on the use of non-GAAP metrics in determining performance. Eighty-nine percent of Investor respondents and 98% of issuer respondents stated that non-GAAP metrics are always or at least sometimes acceptable, depending on the metrics. This overwhelming support for the status quo should be a relief for REITs, which often use funds from operations (“FFO”) and adjusted funds from operations (“AFFO”), both of which are non-GAAP measures, in evaluating performance. We hope that this result will encourage ISS to recognize that FFO and AFFO are broadly accepted and non- controversial metrics for evaluating REIT performance.

Unilateral Bylaw Amendments: Last year, ISS introduced a policy of recommending against directors if a board unilaterally amends the bylaws to, in ISS’s view, “materially diminish shareholder rights.” This year, the Survey asked for how long should ISS penalize directors in the event of such an amendment. Fifty-seven percent of Investors said that ISS should recommend against incumbent director nominees until the bylaw amendment in question is revoked. Only 8% of Investors stated that ISS should recommend against directors only at the annual meeting following the bylaw amendment (which is ISS’s typical practice).

Respondents who answered that directors should be held accountable until the rights are restored were further asked which types of bylaw amendments warrant such a reaction. A large majority of Investors stated that (i) self-classifying, (ii) diminishing stockholders’ right to call a special meeting, (iii) introducing supermajority vote requirements, (iv) fee-shifting requirements for unsuccessful litigants and (v) restricting third-party director compensation, would so warrant. A smaller majority of Investors stated that making advance notice bylaws more burdensome or increasing authorized capitalization would warrant a negative recommendation.

Penalizing directors of corporations for more than one annual meeting would further exacerbate ISS’s already disproportionate reaction to these single corporate decisions. We continue to be amazed that ISS would consider recommending against directors for adopting just one bylaw amendment that ISS doesn’t like, even though those same directors may have guided the company to sound economic performance.

Pre-IPO Charter and Bylaw Amendments: ISS inquired about charter and bylaw amendments at private companies in the run-up to an initial public offering (“IPO”). Fully 48% of Investors stated that boards should not adopt charter or bylaw provisions that “negatively impact” stockholder rights before an IPO and, thus, ISS should consider recommending against the election of directors at the first annual meeting after the IPO solely because of the company’s corporate governance profile at the time of the IPO. This result is particularly egregious because a company’s corporate governance profile is clearly disclosed to all potential purchasers at the time of the IPO.  All potential purchasers then have the opportunity to evaluate a company’s corporate governance profile before making their investment decision. Contrary to what ISS may think stockholders want, there may be investors who buy the stock because of those provisions that offend ISS.  Furthermore, pre-IPO companies have ample opportunities to negotiate with underwriters to arrive at prudent corporate governance policies. In a society that purports to value pluralism and in an economy that purports to value choice, we do not believe that ISS should attempt to substitute its “we know what’s best for you” vision of corporate governance at all public companies from day one.

Equity Compensation for Non-Executive Directors: In response to a Survey question regarding which types of equity compensation are appropriate for non-executive directors, a majority of Investors responded that common stock or time-vesting restricted stock are appropriate; a majority also responded that performance-vesting restricted stock or stock options are inappropriate. While issuers often diverged from Investors in their responses to other issues, on this one they tended to concur as a majority of Issuers stated that common stock or time-vesting restricted stock is appropriate but that performance-vesting shares are inappropriate. However, unlike Investors, a slight majority of Issuers (50.6%) stated that stock options may be an appropriate form of compensation to non-executive directors.

Material Restrictions on Proxy Access: The Survey also asked respondents whether, “in the event that a shareholder proposal to provide proxy access receives majority support, and the board adopts proxy access with material restrictions not contained in the shareholder proposal, what types of restrictions should be viewed as sufficiently problematic to call into question the board’s responsiveness and potentially warrant negative votes on directors.”* ISS noted that it generally recommends in favor of proposals with three-percent voting power thresholds, three-year holding requirements, minimal or no limits on the number of stockholders permitted to form a nominating group and a nominating cap of 25% of the board. Investors basically responded that any deviation from an approved proposal is unacceptable. A majority of Investors stated that a negative recommendation for directors would be warranted for: (i) an ownership threshold of greater than three percent, (ii) a holding period of greater than three years, (iii) a cap on nominees of less than 20% of the board, (iv) an aggregation limit for the nominating group of less than 20 stockholders, (v) re-nomination restrictions if a proxy access nominee fails to receive a stipulated level of support, (vi) more restrictive advance notice requirements, (vii) information disclosure requirements that are more extensive than those required of the company’s nominees and (viii) restrictions on third-party compensation.

This result is worrisome. Proxy access is a new and complex area of corporate governance which demands a more nuanced approach. Boards, especially those at companies whose stockholders have approved a proxy access proposal, should carefully consider all of the variables in such a policy and adopt a proxy access policy that is right for the company. In our experience, proxy access proposals often do not contain all of the details that a final policy would contain (indeed, the Proxy Rules stipulate that the proposal and the supporting statement may not exceed 500 words).

ISS should not substitute its judgment for the board’s and stipulate exactly what every proxy access policy should look like.  In weighing what is in the company’s best interests, directors should not let the threat of a negative ISS recommendation keep them from designing a company-specific proxy access policy.

In addition, the Survey sought feedback regarding certain other topics for U.S. issuers, including (i) net operating loss poison pills, (ii) overboarding, (iii) independence determinations for directors who are former officers, employees or consultants, (iv) controlled companies and (v) disclosure relating to capital allocation or share buybacks. Finally, the Survey asked several other questions pertaining only to issuers in certain other areas of the world.