Shareholder Activism and Defensive Measures

The ebb and flow of shareholder activism and defensive measures will persist in 2016. Companies will continue to struggle with market uncertainty and activists will continue to take advantage of depressed stock prices and other opportunities to gain support for their agendas. For companies, this means continuing pressure to perform well, avoid issues that tend to give rise to activist intervention and ensure that they have adopted best practices and can defend their positions on key emerging issues.  In addition, management teams and boards should continue to strive to have a well-articulated strategic plan and coordinated stakeholder messaging as strategic plans and stakeholder engagement will receive increased scrutiny in these uncertain markets.

Take-over bids and shareholder rights plans

The status of the Canadian Securities Administrators’ (CSA) proposals concerning take-over bids continues to remain in a holding pattern as we wait for the final rules. As previously discussed, the CSA have proposed amendments that would increase the minimum deposit period applicable to a take-over bid from 35 days to 120 days, subject to certain limited exceptions. There would also be a mandatory minimum tender condition of 50% of independent shareholders, among other requirements. Once implemented, these changes are expected to decrease reliance on shareholder rights plans (or “poison pills”) as a defensive tactic, although we expect that rights plans may continue to be useful in some specific circumstances, e.g. preventing creeping bids and lock-up agreements. The final rules implementing the proposed amendments are expected to be published in 2016, with some lead time before implementation.

In the meantime, Canadian issuers continue to balance the benefits of adopting or renewing a shareholder-approved rights plan with adopting a tactical plan when faced with an unsolicited bid. In the shadow of the impending rule changes, the M&A playbook in Canada continues to toggle between the old assumption that a pill would be cease traded within 45 to 75 days and the proposed rule that would require a bid to remain open for 120 days. While many have wondered whether the proposals reflect the CSA’s current perspective on the underling policy considerations, recent decisions seem to be signaling that it is business as usual. In Canadian Oil Sands and Red Eagle, the ASC and BCSC, respectively, cease-traded the targets’ SRPs in advance of the 120-day period, applying their conventional rationale to determine when a pill “must go.”  With respect to shareholder-approved rights plans, ISS’ published policy still reflects its historical criteria that a rights plan should not contain a permitted bid period of greater than 60 days and it remains to be seen how ISS will respond to strategic plans that attempt to accommodate the regime change.

Proxy access

While proxy access itself is not new, it will continue to be the subject of discussion, given recent developments in both the U.S. and Canada. South of the border, proxy access gained renewed prominence as a result of the Securities and Exchange Commission (SEC) being mandated to consider the issue under the Dodd-Frank Act. Even though the rule adopted by the SEC was invalidated by the courts, enough momentum was generated to see a marked rise in proxy access proposals from shareholders and the pre-emptive voluntary adoption of proxy access by U.S. issuers – an illustration of how “private ordering” can sometimes overtake public regulatory processes. Proxy access proposals and those implemented voluntarily are typically modelled on the invalidated SEC rule and call for shareholders (or shareholder groups) to have the right to nominate candidates where they have held at least 3% of voting power for a minimum of 3 years. Outside the shareholder proposal mechanism, proxy access is also increasingly being promoted by institutional investors.

Similar efforts are underway in Canada. By way of background, under Canadian corporate law a shareholder (or group) with 5% of the company’s outstanding shares who has held such shares for six months is already permitted to nominate directors through the shareholder proposal mechanism, and such nominees are required to be included in the company proxy circular. While the exercise of this right is not without challenges and limitations (and is not frequently used), it arguably amounts to a form of proxy access that – in contrast with the U.S. situation – is already enshrined in Canadian corporate law. Nevertheless, the Canadian Coalition for Good Governance (CCGG) is advocating for legislative changes, as put forward in its recent proposal on proxy access, that would broaden proxy access by making it easier and less costly for shareholders. An example of how the CCGG proposal would achieve this is through the relaxation of proxy solicitation rules as they apply to nominating shareholders.

Until changes of this type are enacted, the CCGG is supporting the voluntary adoption of an enhanced form of proxy access by Canadian issuers. The model envisioned by the CCGG would see shareholders entitled to access at an ownership level of 5% for corporations with a market capitalization under $1 billion and 3% for those with a market capitalization above $1 billion. No hold period would be imposed on shareholders, contrasting with the three-year minimum hold period in the invalidated SEC rule and the six-month period under Canadian corporate law. Among other things, the number of nominees that shareholders would be entitled to propose would be limited to the lesser of three or 20% of the total number of directors. The absence of a hold period is likely to be among the more contentious aspects of this proposal, as  arguably providing an avenue for short-term investors to utilize this mechanism to their benefit.  In addition, the voluntary adoption of the CCGG proposal by Canadian issuers prior to legislative amendments will not alleviate one the CCGG’s principal concerns about the current regime, being that shareholders must comply with the proxy solicitation rules, including (in most instances) preparing and filing a dissident circular, in order to solicit proxies for their nominees.   

Shortly after releasing this proposal, the CCGG published a related proposal advocating the use of universal proxies in contested director elections.

While it has yet to be seen what impact the CCGG proposal will have, including the extent to which Canadian issuers receive proxy access shareholder proposals, proxy access is another example of the significant influence of U.S. governance practices in Canada.

Related to this development, in 2016 we also expect to see a continued increase in shareholder proposals including with respect to term limits for directors and diversity and environmental, social and governance proposals generally. While still relatively uncommon in Canadian proxy circulars outside of larger market capitalization issuers, this is another area that witnessed slow but steady growth in 2015, with an increase in both the number of and shareholder support for proposals, including more proposals being made to smaller issuers outside the TSX Composite Index.

Majority voting for director elections

While majority voting is now prevalent given the TSX’s mandatory requirements, 2016 will likely see increased pressure to meet the expectations of shareholders when an individual director fails to achieve majority support. In 2015, there were a small number of failed votes but their impact was blunted by the fact that issuers are not obligated to accept resignations from “failed” nominees. As a consequence, we expect that the TSX and institutional shareholders may increase their scrutiny of both policies and practices to ensure that majority voting “has teeth”. At the very least, they are likely to ask that issuers provide a reasonable and clear basis for refusing to accept resignations.

Board Composition – Diversity and Tenure

Results of mandatory disclosure

Board composition will continue to be a major issue in 2016. Canadian companies have now completed their first year of mandatory disclosures under the new diversity disclosure rules and the data that this disclosure has generated will help to shape the discussion around board diversity and renewal. Contentious issues such as director term limits and mandatory retirement are likely to be increasingly discussed as possible mechanisms for promoting the achievement of board composition goals.

Among the various studies and surveys conducted on how Canadian issuers responded to the new requirements was one published by the CSA itself, reviewing the disclosures of the 722 TSX issuers. While results vary markedly when broken down by industry and market capitalization, some general statistics include the following:

  • 14% of the issuers stated that they had a written policy on the identification and nomination of women directors, although the rate was higher for larger issuers: closer to 30% for those with market capitalizations of $2-$10 billion and closer to 40% for those over $10 billion.
  • 15% of the issuers surveyed added one or more women to their board in the past year, with the result that 49% now have at least one female board member and 60% have at least one woman in an executive officer position.
  • 19% of issuers surveyed had adopted director term limits (56% disclosed other mechanisms of board renewal), with adoption rates for term limits being closer to 40% for issuers with a market capitalization of over $2 billion.

The position of proxy advisors

While neither ISS nor Glass Lewis have taken any specific positions on gender diversity, their approaches do signal growing support for board diversity and renewal. In its 2016 Proxy Season Guidelines, Glass Lewis notes that “nominating and governance committees should consider diversity when making director nominations within the context of each specific company and its industry” and that “shareholders are best served when boards make an effort to ensure a constituency that is not only reasonably diverse on the basis of age, race, gender and ethnicity, but also on the basis of geographic knowledge, industry experience, board tenure and culture.” However, with respect to the term and age limits, Glass Lewis maintains the position that such limits are typically not in shareholders’ best interests. It reiterates that director experience is a valuable asset to shareholders but supports the routine evaluation of directors and periodic board refreshment.[1]

Similarly, while not addressed in its 2016 Canada Proxy Voting Guidelines for TSX-Listed Companies, in its Governance QuickScore 3.0 pursuant to which certain issuers are rated on their governance practices, ISS has included the number of women on an issuer’s board as a factor scored in Canada and the U.S. In support of this position, ISS points to studies showing that increasing the number of women on boards of directors correlates with better long-term financial performance. With respect to director term limits, the proportion of non-executive directors on the boards with lengthy tenure is now also a factor scored by ISS in Canada. ISS considers “lengthy tenure” by non-executive directors as greater than nine-years of service (which is on the low end of the historical 9-12 years typically applied). It notes that tenure of more than nine years potentially compromises a director’s independence.[2] While recognizing the existence of power imbalances between new and senior board members, as well as divergent loyalties to the issuer and management team depending on the length of time spent with either group, ISS believes that a balanced board with a diversity of viewpoints and experience is ideal.

CCGG policy on board diversity

In October of 2015, the CCGG also published a new policy on board diversity. Acknowledging the general benefits of diversity and the persistent under-representation of women, the CCGG notes that gender diversity is an appropriate manner for improving board quality. Moreover, the CCGG believes that corporate response to the board diversity issue should go beyond the CSA-mandated “comply or explain” approach and expresses the view that the CSA should be recommending the adoption of gender diversity policies in corporate governance “best practices” guidelines.

The CCGG further recommends more disclosure regarding the board recruitment process and that the process be professionalized, as opposed to relying on the existing board’s circles of relationships to identify candidates. Rather than recommending director term limits or mandatory retirement, the CCGG advocates strengthening the annual evaluation process of the full board, board committees and individual directors in a manner that incorporates consideration of the balance between experienced and fresh insights in board composition.

Say-on-Pay and other Executive Compensation Matters

It has been five years since the Dodd-Frank Act made say-on-pay mandatory in the United States and average rates of support on say-on-pay votes remains very strong. When the range of issuers is broadened to include the entire Russell 3000 index, the failure rate in 2015 was still less than 3%. In Canada, say-on-pay votes remain voluntary. Among the 100 largest issuers that have implemented the practice, the average level of support declined slightly in 2015 but was still above 90%. However, 2015 also saw a number of high profile examples where shareholders used a say-on-pay vote to send a message about corporate compensation practices. These trends indicate that in preparing for the upcoming proxy season, Canadian companies – even those that are not facing pressure to implement say-on-pay – should at least ensure that they have carefully considered the impact of their compensation policies and practices, with a particular emphasis on pay for performance.

Even for companies not directly impacted by proxy advisors, ISS and others continue to influence the proxy season dialogue, specifically with respect to the design and implementation of equity compensation plans. For 2016, ISS will look critically at single-trigger accelerated vesting on a change of control for equity plans, and the settlement of performance-based equity at target or above in the event of accelerated vesting on a change of control. While ISS has moved to a “scorecard” methodology for Canada that attempts to balance a number of factors to determine an issuer’s ultimate governance “score,” it will continue to vote against the following types of features, irrespective of any countervailing factors:

  • discretionary or insufficiently limited non-employee director participation;
  • amendment provisions that permit broad amendment powers without shareholder approval; and
  • a history of re-pricing stock options without shareholder approval.

A number of other SEC compensation-related may alter the Canadian landscape in the coming years. Among these are:

  • the clawback listing standard rule – rules requiring companies to implement policies under which they will claw back or recoup compensation from executives upon the occurrence of certain specified events;
  • pay-ratio disclosure – disclosure regarding the relationship of CEO pay to median-employee pay;
  • pay versus performance disclosure – disclosure in a tabular format of executive compensation actually paid vs. total shareholder return; and
  • broader anti-hedging policy disclosure – disclosure as to whether employees in general (not just named executive officers and directors) are subject to anti-hedging restrictions.

Although rules of this nature are not yet in place in Canada, similar initiatives have been the subject of shareholder proposals from time to time and will continue to attract the attention of shareholders as they become routine and more prominent in the United States. Other developments that continue to make inroads into the Canadian landscape include a greater emphasis on director and executive share ownership and share retention requirements and broader shareholder engagement and related disclosure, including through specific board or committee processes.

If there is a single take-away from these developments, it is the need for companies to ensure proper shareholder engagement and an effective and well-developed communication process that allows their message to be clearly articulated and understood by shareholders and other key stakeholders. This also means greater focus on the shareholder communication mechanisms outside the regular proxy disclosure cycle, including through specific board or committee processes. In 2015, we saw companies adopt defensive positions on an urgent basis in response to attacks by short sellers, a development that serves to underscore the need to be able to mobilize all relevant communication channels quickly, as and when needed. It also illustrates the advantage of having a well-articulated and consistent message to rely on when faced with these or other similar challenges.