Annual meeting season for Canadian public companies starts soon. What new requirements and continuing trends will companies face in 2015? This update discusses some of them.
- New requirements: The following new requirements will impact Toronto Stock Exchange (TSX) companies:
- majority voting for election of directors
- disclosure regarding director term limits
- disclosure regarding women on boards and in senior management
- Continuing trends: Although not new or required, the following trends in corporate governance are continuing, some more so than others:
- advance notice provisions for director nominations
- compensation clawbacks
- shareholder activism
Majority Voting for Election of Directors
New for the 2015 proxy season1 is a requirement for majority voting for the election of directors. An initiative of the TSX, it is applicable to companies with securities listed on the TSX.2,3
Majority voting means that each director must be elected by more than 50 percent of the votes cast at a shareholder meeting. That is different than the corporate law requirement, where votes for director election are either "for" or "withheld". Under corporate law, a vote withheld is not a vote against. The majority of director elections are uncontested – the number of nominees for election is the same as the number of directors to be elected. In those cases, the outcome is not in doubt. A director will be elected even if a large number of "withheld" votes indicates shareholder disapproval.
The TSX's policy reason for the new requirement is "to improve corporate governance standards in Canada by providing a meaningful way for security holders to hold individual directors accountable." The TSX says that "currently, Canadian investors have a less effective voice in electing directors than investors in certain other jurisdictions because neither securities nor corporate law in Canada require issuers to have majority voting for director elections at uncontested meetings."4
Many Canadian public companies adopted majority voting policies long before the new requirement came into effect. This was largely at the urging of "best practice" proponents such as the Canadian Coalition for Good Governance (CCGG), an organization representing the interests of institutional shareholders. CCGG first issued a recommendation for majority voting in 2006.
Exempted from the new rule are contested meetings, where the number of directors nominated for election is greater than the number of seats available on the board. Those rare cases are true elections, where the nominees who receive the most votes ought to be elected, whether or not they garner a majority of the votes cast. Also exempted are majority controlled companies, where a security holder beneficially owns, controls or directs voting securities carrying at least 50 percent of the voting rights for the election of directors. Majority voting occurs by definition in those cases. Finally, as noted above, the new rule applies to companies with securities listed on the TSX. The many Canadian public companies that are listed on the TSX Venture Exchange and the Canadian Securities Exchange do not need to comply.
TSX-listed companies must adopt a majority voting policy (or, less likely, be subject to one by statute or the company's articles or bylaws). The policy must be described in the management information circular sent to shareholders for a meeting to elect directors and have these attributes:
- A director must immediately tender his or her resignation if not elected by a majority of votes cast.
- The board must determine whether or not to accept the resignation within 90 days after the meeting.
- The board must accept the resignation absent "exceptional circumstances". Those circumstances are for the board to determine, consistent with the directors' fiduciary duty to act in the best interests of the company.
- The resignation must be effective when accepted.
- The director cannot participate in the board (or committee) meeting to consider his or her resignation.
- The company must issue a news release to report the board's decision, including reasons if the director's resignation is not accepted.
Majority voting is the latest initiative taken by the TSX regarding election of directors. It follows rule changes that were adopted in late 2012 for the 2013 proxy season,5 mandating the following:
- Election of all directors at each annual meeting (no staggered boards).6
- Voting for each director (no slate voting).7
- Disclosure of whether a majority voting policy has been adopted and, if not, an explanation of practices for electing directors and why a majority voting policy has not been adopted (this "comply or explain" approach has now been replaced by the new requirement to adopt a majority voting policy).
- A news release announcing voting results for each director (by percentage or number).8
Director Term Limits
Also new for the 2015 proxy season is a requirement for TSX companies to disclose director term limits or other board renewal mechanisms.9 If there are none, then the company must explain why. This is the so-called "comply or explain" approach that is a feature of many aspects of Canadian corporate governance disclosure. The disclosure must be contained in the management information circular for the company's annual meeting (or, less likely, in its annual information form).
Exempted from the new rule are "venture issuer" companies, which are listed on junior stock exchanges such as the TSX Venture Exchange and the Canadian Securities Exchange. The practical effect is that the new rule only applies to TSX-listed companies.
Term limits are relatively uncommon among Canadian companies. The Canadian Spencer Stuart Board Index 2014 reports that of the 100 largest Canadian public companies by revenue, only 21 had term limits, ranging from 7 to 15 years.10 Mandatory retirement is more common than term limits for large companies. There are of course many more Canadian public companies in addition to those among the largest 100; very few of them have director term limits.
Director term limits have not received much attention from proponents of corporate governance best practices. Why then have Canadian securities regulators adopted director term limit disclosure? The stated policy objective is that "regular renewal of board membership contributes to the effectiveness of a board." Also, "director term limits can promote an appropriate level of board renewal and in doing so provide opportunities for qualified board candidates, including those who are women."11 That second point is discussed in the next section.
Women on Boards and in Senior Management
The biggest change for the 2015 proxy season is a new disclosure requirement regarding women on boards and in senior management.12,13 Like director term limits, the approach is "comply or explain" and the disclosure must be contained in the management information circular for the company's annual meeting (or, less likely, in its annual information form). Unlike some other countries, most notably Norway (at 40 percent), Canadian companies will not be subject to a mandated quota of women directors.
Like director term limits, this new requirement applies just to TSX-listed companies. Interestingly, neither the Alberta Securities Commission (ASC) nor the British Columbia Securities Commission adopted it. In the case of Alberta, the stated reason was that the disclosure requirement did not fall within the "ASC's mandate... to protect investors and foster a fair and efficient capital market in Alberta." However, that objection has little practical impact. Applicability really depends on stock exchange listing. If an Alberta-based company is listed on the TSX, then it is bound by the requirement because the Ontario Securities Commission ultimately regulates the TSX.
Recent experience shows that even without the new requirement (or perhaps in anticipation of it), the number of women on Canadian boards is increasing. The Canadian Spencer Stuart Board Index 2014 reports that of a constant set of 81 of the 100 largest Canadian public companies by revenue, the percentage of directors who are women increased from 15 percent in 2009 to 22 percent in 2014. For new non-executive director appointments at the 100 largest Canadian public companies, the percentage increased from 13 percent in 2009 to 43 percent in 2014. However, Canada has numerous public companies in addition to those among the largest 100; for those companies, the percentage of women directors is considerably lower.
Specifics of the disclosure requirement are:
- Disclosure of any written policy regarding the representation of women on the company's board (and, if the company has a policy, a summary of it and disclosure of implementation, achievement of objectives and measurement).
- Consideration of the level of representation of women in the director identification and selection process.
- Consideration of the level of representation of women in executive officer appointments.
- Any targets voluntarily adopted regarding the representation of women on the board and in executive officer positions.
- The number and proportion of women on the company's board and in executive officer positions with the company and its major subsidiaries.
- If the company does not have a policy or does not comply with any of the other items above, then it must explain why – "comply or explain".
What is the policy reason behind this new requirement? It started with a statement in Ontario's May 2013 budget, indicating the government's support for broader gender diversity on boards and in senior management. This led to a request that the Ontario Securities Commission examine the issue. Ultimately, the policy objective was stated by the participating securities commissions as being to "increase transparency for investors and other stakeholders regarding the representation of women on boards and in senior management" and "assist investors when making investment and voting decisions."14
How will companies respond to the new requirement? To date, with some exceptions, Canadian public companies have hardly addressed at all their record of women on boards and in senior management, although sometimes it is included in a broader discussion of diversity. The experience in Australia, which adopted a "comply or explain" approach in 2010, may serve as useful guide for TSX-listed companies.
Advance Notice Provisions
Advance notice provisions are fast becoming more common in this age of increased shareholder activism. They require a shareholder who plans to nominate a person for election as a director to give advance notice to the company. The purpose is to prevent surprise nominations. By ensuring that the company and its shareholders have adequate notice and information on a shareholder nominee for election, shareholders are able to make an informed decision. Conveniently for the company, advance notice provisions also allow time to formulate a response to an unwanted nomination.
The key mechanics of an advance notice provision are that at least 30 days notice to the company is required. The information that a nominating shareholder must provide regarding itself and the director nominee is also specified. It is the same information as must be included in a dissident proxy solicitation circular.
Advance notice provisions have been used in the United States for over 20 years. The provisions started to appear in Canada after 2010 with TSX Venture Exchange junior mining companies and are now widely used.
Implementation is typically by amendment of existing articles or bylaws or adoption of a new special purpose bylaw. In either case, shareholder approval is required. The experience is that most shareholder votes have been favorable. Advance notice provisions can also be adopted by board of director policy. That approach is more flexible (no shareholder approval, easy to amend), but there are enforceability concerns.
Based on the current trajectory, we expect that the majority of Canadian public companies will adopt advance notice provisions in the coming years, if they have not already done so.
A shareholder vote approving a company's approach to executive compensation is known as "say-on-pay". The vote is not binding on the company's directors. Instead, it is a means for shareholders to indicate their general approval or disapproval of the company's executive compensation. But if shareholders have concerns, the company has probably already heard from some of them, so why voluntarily hold a say-on-pay vote? It arguably serves to shine a light on an issue and provides all shareholders with a chance for input.
Say-on-pay votes are not required in Canada. They are required in the United States, United Kingdom, Australia and some other countries, with the vote being advisory or mandatory, depending on the jurisdiction. Adoption in Canada is mostly confined to larger companies that are inter-listed on a foreign stock exchange. Very few other Canadian companies have adopted say-on-pay.
The Canadian Coalition for Good Governance (CCGG) recommends say-on-pay, and published a model policy in September 2010. Comment on say-on-pay was sought by the Ontario Securities Commission in January 2011 and by Industry Canada (which has responsibility for the Canada Business Corporations Act) in December 2013. To date, there is no regulatory initiative to require say-on-pay and interest in Canada seems to be waning. Most say-on-pay votes pass by a healthy margin, and some commentators have suggested that a low approval vote may be more of a comment on poor share performance than on executive compensation.
A compensation clawback requires an employee, typically an executive, to forfeit previously awarded compensation. The standard reasons are restatement of financial statements, misconduct or both, the latter called a "double trigger".
In the United States, the 2002 Sarbanes-Oxley Act requires Securities Exchange Commission (SEC) action to recover compensation. It is limited to the CEO and CFO, requires a double-trigger event and is infrequently used. Wider applicability is expected to come under the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. It will require U.S. stock exchange listed companies to have a compensation clawback policy with a single trigger – restatement of financial statements. However, like many aspects of the Dodd-Frank Act, actual implementation of compensation clawback is waiting for development by the SEC of detailed regulations.
In Canada, compensation clawbacks are not required and there are no proposals under corporate law or by securities commissions or stock exchanges to implement them. Only a few Canadian companies, mostly large capitalization, Canada-U.S. inter-listed companies, have a compensation clawback policy. If adopted, the policy must be disclosed in the company's annual executive compensation disclosure.15
Proxy contests are a relatively new phenomenon in Canada. Historically, a proxy contest was typically the result of a breakdown at the board or a fight between management and a large shareholder. The recent trend is action by activist institutional investors.
Recent Canadian examples are:
- CP Rail – successful 2012 election of Pershing Square nominee directors, to change management.
- Agrium – unsuccessful 2013 attempt by JANA Partners to elect directors, to spin off retail business.
- Talisman Energy – successful 2013 appointment of two Carl Ichan nominee directors, subject to a "standstill".
- Various recent asset transactions attributed to behind-the-scenes discussions with activist investors.
A number of factors favor activist shareholders in Canada:
- The right to obtain information regarding certain beneficial owners of shares.
- A higher threshold for early warning declaration of share ownership (10 percent in Canada versus five percent in the United States).
- The ability to solicit proxies from up to 15 shareholders without complying with formal proxy solicitation rules.
- The ability to solicit proxies by "broadcast, speech or publication", which includes the Internet.
- The ability of a five-percent shareholder (individual or group) to requisition a special meeting of shareholders.
- The ability of a five-percent shareholder (individual or group) to nominate directors for inclusion in a management proxy solicitation circular.
- The ability, in certain cases, to carry out "stealth" nominations of directors from the floor at a shareholder meeting.
- Annual election of directors and the relative absence in Canada of "staggered boards".
- The power of voting recommendations by proxy solicitation firms (notably, Institutional Shareholder Services Inc. and Glass, Lewis & Co.).
- The willingness of Canadian securities commissions and courts to set aside shareholder rights plans (poison pills) after sufficient time has elapsed to find a white knight.
What is a target company to do to prepare or respond? The answer is much the same as for an unsolicited purchase offer. Companies will benefit from advance preparation. This will mean:
- Knowing your shareholders and having open lines of communications with them.
- Monitoring changes in shareholdings and market activity.
- Having a response team, which includes key company personnel and financial, legal and proxy advisors, ready to be assembled on short notice.
- Developing messages for immediate response that preserve the impartiality of the board.
- Having a drill to practice the company's response, to become familiar with the timelines and demands on the company and to improve preparedness for contingencies.