Companies preparing for their annual shareholder meetings will need to consider a variety of factors, including new Securities and Exchange Commission (SEC) requirements, guidance from Institutional Shareholder Services Inc. (ISS) and Glass, Lewis & Co. (Glass Lewis), and activist shareholder concerns.
A. New Requirements for Proxy Statements and Form 10-Ks
Pay Ratio Disclosure
In September 2017, the SEC issued an interpretive release and compliance and disclosure interpretations to assist companies in complying with the new pay ratio disclosure required by the Dodd-Frank Act and Item 402 of Regulation S-K. Under the new Regulation S-K requirements, proxy statements or Form 10-Ks filed in 2019 must generally disclose the following:
- the median of the annual total compensation of all of the company’s employees except for its CEO;
- the annual total compensation of the company’s CEO; and
- the ratio of these two amounts.
The SEC’s guidance provides companies with flexibility in calculating their pay ratios and in determining which workers must be included in the calculation. Among other things, companies may use any method to calculate their pay ratios that is reasonable and that relies on reasonable estimates and assumptions, and may use the methods they would typically employ when determining which workers are employees whose pay must be disclosed.1
Shareholder Proposal Guidance
On October 23, 2018, the SEC’s Division of Corporation Finance issued Staff Legal Bulletin No. 14J (CF), which provides guidance on the applicability of the “ordinary business” and “economic relevance” exceptions under Rule 14a-8 to a public company’s obligations to include shareholder proposals in its proxy materials. The new guidance outlines substantive factors that a board may consider when determining that a shareholder proposal is not significantly related to the company’s business. These factors may include:
- the extent to which the proposal relates to the company’s core business activities;
- quantitative data showing the significance of the matter addressed by the proposal;
- whether the company has already addressed the issue in some way, and the extent of shareholder engagement on the issue;
- whether anyone other than the proponent has requested the type of action or information sought by the proposal; and
- whether the company’s shareholders have previously voted on the matter.
The new guidance recommends that companies include these or similar factors in their no-action requests. The guidance also explains how the SEC will determine whether a proposal is excludable because it seeks to “micromanage” the company and clarifies when the “ordinary business” exception will apply to proposals that address senior executive or director compensation.
B. ISS 2019 Proxy Season Updates
In November 2018, ISS, a proxy advisory firm, released updates to its US Proxy Voting Policies and Procedures for its voting recommendations for annual stockholder meetings occurring on or after February 1, 2019. New recommendations and policy clarifications include:
- Gender Diversity: For meetings of companies in the Russell 3000 or the S&P 1500 indices occurring on or after February 1, 2020, ISS will generally recommend voting against the nominating committee chair if the board has no gender diversity. Other directors who are responsible for the board nomination process may also be impacted on a case-by-case basis, and ISS will also consider any exceptional circumstances explaining the absence of board gender diversity on a case-by-case basis. The 2020 implementation date is intended to provide companies with a one-year grace period, which will allow time for boards that wish to do so to recruit qualified female candidates. ISS will also consider case by case any exceptional circumstances explaining the absence of board gender diversity. This change builds on ISS’s 2018 policy of highlighting companies that have no female directors in its proxy reports.
- Conflicting and Excluded Proposals: ISS is seeking to discourage companies from ratifying existing shareholder rights in order to use Rule 14a-8 to exclude shareholder proposals that seek more favorable shareholder rights. Where boards ask shareholders to ratify existing charter or bylaw provisions, ISS will consider factors such as the board’s rationale for seeking ratification, actions to be taken by the board should the ratification fail, and disclosure of shareholder engagement in making its voting recommendation. ISS will also generally recommend voting against management ratification proposals that do not align with best practices. In addition, a failed management ratification proposal could result in adverse voting recommendations against individual directors, governance committee members or the full board if they failed to take appropriate actions in response to the failed management ratification proposal in the previous year.
- Board Attendance: ISS will issue adverse voting recommendations against any director with three or more consecutive years of “chronic poor attendance” (defined as less than 75% attendance at board and committee meetings without reasonable explanation). ISS’s new guidance also outlines the thresholds after which it will issue negative voting recommendations against board nominees, nominating or governance committee members, and nominating or governance committees. In addition, ISS may also apply this policy to directors with a long-term pattern of absenteeism.
- Environmental and Social Issues: ISS will consider whether there are significant controversies, fines, penalties or litigation associated with the company’s environmental or social practices when evaluating environmental and social shareholder proposals.
ISS also announced that it will make minor adjustments to the methodology for calculating the Equity Plan Scorecard, add economic value-added data to its research reports, codify its approach to evaluating reverse stock splits at companies that are not listed on major exchanges, and delay implementation of its policy on excessive non-employee director compensation from the 2019 proxy season until the 2020 proxy season.
C. Glass Lewis 2019 Proxy Season Updates
In November 2018, Glass Lewis, a proxy advisory firm, released updates to its US Policy Guidelines for its voting recommendations for annual stockholder meetings occurring on or after February 1, 2019. New recommendations and policy clarifications include:
- Gender Diversity: Glass Lewis will recommend voting against the nominating committee chair (and, in some cases, against other members of the nominating committee) of a board that has no female members. In addition, Glass Lewis will generally support shareholder proposals that request disclosure about the diversity of a company’s workforce as well as those asking for details on how companies are promoting diversity within their workforce.
- Conflicting and Excluded Proposals: Glass Lewis codified its policy on conflicting proposals by management and shareholders. For proposals seeking to lower the ownership percentage required for calling a special meeting, Glass Lewis will generally recommend voting for the lower threshold and against the higher threshold. For conflicting proposals seeking to establish new special meeting rights at companies that do not currently have such rights, Glass Lewis will generally recommend voting for the shareholder proposal and abstaining from voting on management’s proposal. Glass Lewis will recommend voting against a proposal by management to ratify existing special meeting rights where the proposal was used to block a shareholder proposal on special meetings from the ballot.
- Virtual-Only Shareholder Meetings: Companies holding virtual-only shareholder meetings should include disclosure in their proxy statements assuring shareholders that they will have the same rights and opportunities that would be afforded by an in-person meeting. Glass Lewis will recommend voting against directors who are members of governance committees at companies without such disclosure.
- Compensation Policies: In determining whether to make a negative say-on-pay recommendation, Glass Lewis will consider factors such as whether a company has added new excise tax gross-up provisions in executive employment agreements. In response to the SEC’s recent amendments to the definition of “smaller reporting companies,” pursuant to which more companies would be eligible to take advantage of reduced disclosure requirements available to smaller reporting companies, Glass Lewis may also make a negative say-on-pay recommendation if a smaller reporting company has materially decreased its proxy statement disclosure regarding executive compensation policies and procedures.
Glass Lewis also codified its pre-existing policies on reviewing auditor ratification proposals and board oversight of environmental and social issues, indicated that it would scrutinize grants of front-loaded awards in its review of a company’s executive compensation program, outlined where it expects clawbacks to be triggered, and clarified which terms of contractual payments and arrangements may contribute to an adverse voting recommendation on a company’s say-on-pay proposal.
ISS and Glass Lewis have not changed their policies relating to proposals authorizing business development companies to sell shares of their common stock below net asset value. Both firms will recommend a “for” vote if such proposals meet certain requirements, such as expiring no more than a year after the proposal’s approval.
D. Activist Shareholder Considerations
Shareholder activism is expected to continue to be prevalent, particularly in areas surrounding environmental and social issues. The 2018 proxy season saw an increase in proposals related to climate change, board diversity (including, but not limited to, gender and tenure), lowering the ownership percentage required for calling a special meeting, and adopting the right for shareholders to act by written consent. Companies should expect similar trends in 2019.