White & Case recently completed its annual study of the exemptions that US-listed Israeli companies take from the corporate governance requirements that apply to US domestic issuers. In total, we reviewed filings by the 62 Israeli companies listed on the NASDAQ Stock Market (“NASDAQ”) and the two Israeli companies listed on the New York Stock Exchange (the “NYSE”).1 We believe that this study will assist listed Israeli companies and those conducting IPOs to determine the appropriate governance practices to adopt.
Summary of Results
The following is a summary of the results and conclusions of the survey:
- Eighteen percent of Israeli companies listed on NASDAQ take no exemption from NASDAQ listing requirements. This number increases to 23 percent when Israeli companies whose only exemption relates to quorum requirements are included. Put differently, over three-fourths of Israeli companies take an exemption from one or more NASDAQ corporate governance requirements.
- Fourty-seven percent of Israeli companies listed on NASDAQ take an exemption from NASDAQ’s requirement of shareholder approval for the establishment or amendment of an equity compensation plan. This compares to 43 percent last year. Companies taking this exemption can establish new, or amend existing, equity compensation plans without shareholder approval, and can generally also reprice or exchange underwater employee stock options without shareholder approval.
- Fifteen percent of Israeli companies listed on NASDAQ take an exemption from NASDAQ’s other shareholder approval requirements regarding the issuance of shares (a) representing more than 20 percent of outstanding voting securities or common stock in certain M&A transactions or private placements at below market prices or (b) in connection with an acquisition of an entity in which a director, officer or substantial shareholder has an equity interest.
- Eighteen percent of Israeli companies listed on NASDAQ take an exemption from the requirement of majority-board independence (this is in addition to a small number of Israeli companies that are exempt from this requirement because they are “controlled companies”). The result of this exemption is that audit committee members are generally the only directors that are required to be independent (e.g., the two external directors required under the Israeli Companies Law and at least one other director who meets audit committee independence standards under the Israeli Companies Law).
- Eighteen percent of Israeli companies listed on NASDAQ take an exemption from the requirement that they establish a compensation committee or that compensation decisions be made by a majority of independent directors, up from 12 percent last year. Twenty-three percent of Israeli companies listed on NASDAQ also take an exemption from the requirement that they establish a nomination committee or that nomination decisions be made by a majority of independent directors, up from 20 percent last year. In addition, 26 percent of Israeli companies take an exemption from the requirement that they adopt a charter or board resolution governing the nominating committee, up from 22 percent last year.
- Only six percent of Israeli companies take an exemption from NASDAQ’s audit committee requirements. The low number of Israeli companies using this exemption reflects the importance of the audit committee and the fact that the Israeli Companies Law has audit committee requirements similar to NASDAQ’s requirements. There is consequently little benefit to be gained from an exemption from NASDAQ requirements.
- Only two Israeli companies are listed on the NYSE, down from three last year. As a result, there is a limited sample for analysis. Both of the NYSE-listed companies take exemptions from most of the NYSE requirements other than exemptions related to audit committees. One of the companies is a controlled company.
- The largest US-listed Israeli company—Teva Pharmaceuticals Ltd. —has taken no substantive exemptions to NASDAQ’s corporate governance requirements. The other members of the Tel Aviv Stock Exchange 25 Index that are traded in the United States have taken various exemptions, but none of them takes a blanket exemption.2
- We believe that Israeli companies should include appropriate disclosures in their annual reports with regard to any potential exemptions that may be taken in the future. The lack of such disclosures may expose the company to claims of omission of material information if the company later chooses to take such exemption.
Analysis and Recommendations
The US Environment
Seven years have passed since the adoption of the Sarbanes-Oxley Act of 2002, and US legislators and regulators are once again focusing on public company corporate governance. In addition, aided by proxy advisory firms, most notably RiskMetrics (formally Institutional Shareholder Services, or ISS), shareholders of US public companies have become increasingly vocal in their demands on companies. The following “shareholder-friendly” trends are notable:
- Recent proxy seasons have seen record numbers of activist campaigns by investors—506 in 2007 and 479 in 2008. These proxy fights and other campaigns resulted in activists gaining board seats at 84 companies in 2008, more than any other recent year (although 2009 data is not yet available).
- In June 2009, the SEC proposed rules that would permit certain qualifying shareholders of a US company to include in the company’s proxy statement nominees for up to 25 percent of the company’s board of directors, thereby saving shareholders the significant expense of printing and mailing their own proxy statement, and waging a proxy battle.3 The State of Delaware, where the majority of public companies in the United States are incorporated, recently amended its corporate law to expressly enable “shareholder access” to a company’s proxy statement.4 There is significant pressure on the SEC to adopt its proposed shareholder access rules for all US public companies despite the fact that the proposal remains highly controversial.
- More than two-thirds of the S&P 500 have adopted “majority voting” practices in lieu of plurality voting. This means that directors in uncontested elections must receive a majority of votes cast and gives teeth to a “no” vote that previously had little effect even if a candidate received a majority of “no” votes.
- There has been significantly enhanced scrutiny of executive compensation. The US House of Representatives just adopted a bill that would provide for an annual vote on executive compensation, known as “say-on-pay.” Many shareholders in the US have been clamoring for such a vote. While non-binding and purely advisory in nature, such a vote would enable shareholders to send a strong message of displeasure to a company’s board. In addition, the SEC recently proposed rules that would require disclosure of a company’s overall compensation policies and practices as they relate to the company’s risk management practices and/or risk-taking incentives if those policies and practices may have a material effect on the company. In addition, disclosure would be required regarding the role of compensation consultants in determining the compensation of directors and executive officers.5
At the same time as the above “shareholder friendly” trends have been occurring, many company boards have taken actions that remain controversial among shareholders. First, a large number of US and non-US companies have repriced underwater options or exchanged them for restricted stock. However, to minimize shareholder criticism, the significant majority of repricings have been so-called “value-for-value” exchanges where, from an accounting standpoint, the value of the securities surrendered is the same as the value of the new securities granted. In addition, the significant majority of US companies have sought shareholder approval. Second, in the face of increased hostile takeover activity and shareholder activism, companies with depressed stock prices have adopted poison pills and some with poison pills that expired have renewed them. This contrasts with recent trends to dismantle poison pills and other anti-takeover measures at many companies.6
How does all of this impact Israeli companies?
The good news for Israeli companies is that almost all of the pending legislative and regulatory developments described above are not applicable to foreign private issuers. Furthermore, with one or two notable exceptions, Israeli companies have largely been immune from the type of shareholder activism that has beset many US companies. Nevertheless, we believe that Israeli companies should consider the following in connection with opting out of NASDAQ or NYSE corporate governance requirements:
- We believe that there is little benefit for Israeli companies from opting out of NASDAQ and NYSE audit committee requirements. While audit committee requirements under the Israeli Companies Law are robust, some aspects of the US requirements do further enhance audit committee functionality. In addition, the United States is the primary trading market for the majority of US-listed Israeli companies, and the NASDAQ and NYSE audit committee requirements pose a limited burden due to the fact that the audit committee requirements under Israeli law are similar.
- Companies should also consider maintaining compliance with the nominating committee, compensation committee and majority independence requirements of the applicable US exchange. Each of these requirements is more burdensome than the audit committee requirements since there is no directly comparable Israeli requirement. A nominating committee is only beneficial when it conducts an annual review of the board’s overall skill set (actual and desired), as well as a review of each director’s contributions to the board (objectively and through self evaluations), both of which put the committee in a better position to determine the optimal slate of director nominees. This is a challenging mandate to fulfill. Nevertheless, a nominating committee is often the ideal forum to carry out this mandate, unless the board itself can fulfill this role. We also believe that a functioning compensation committee can be of great value for public companies, particularly in an environment where there is increased scrutiny of executive compensation.
Finally, compliance with the technical director independence requirements can be challenging and the majority independence requirement is more stringent than the standards adopted by many non-US exchanges.7 Nevertheless, these standards have become hallmarks of good governance in the United States and compliance is generally not burdensome. We believe that Israeli companies that opt out of the majority independence requirements should consider limiting the number of executive officers and other individuals with significant non-stock ties to the company that serve on the board.
- In last year’s study, we forecast that the economic downturn would result in a need to increase the number of shares available under existing plans or to reprice or exchange outstanding underwater options. This year, the number of Israeli companies that opted out of NASDAQ Rule 5635(c) requiring shareholder approval for the establishment or amendment of an equity compensation plan did increase marginally. However, the number of companies that included language in their Form 20-Fs warning investors that they might opt out in the future increased significantly. We believe this is a prudent step and that boards should consider taking advantage of this exemption if they are contemplating a repricing or anticipate a need to increase the number of shares available under an equity compensation plan. We caution that any such action may still be subject to scrutiny by shareholders and companies should strongly consider complying with some or all of the guidelines provided by RiskMetrics with respect to any option repricing. We also believe that Israeli companies should consider warning investors that they may opt out of the shareholder approval requirement for below market issuances of more than 20 percent of a company’s outstanding voting securities in a private placement under NASDAQ Rule 5635(d) and issuances that result in a change in control under NASDAQ Rule 5635(b). The economic downturn has increased the need for many companies to raise capital and depressed stock prices make it easier to exceed the 20 percent threshold or cause a change in control (presumed by NASDAQ to occur when a company without a 20 percent shareholder issues additional shares so that after giving effect to such issuance it has such a shareholder). These triggers can be met in a range of different transactions, such as PIPEs and registered direct offerings, as well as traditional private placements. The need to obtain shareholder approval is burdensome in these transactions, many of which are time sensitive.
Finally, we note the following points with respect to governance in general:
- Compensation practices are worthy of special attention. Disclosure requirements for foreign private issuers regarding executive compensation are governed by Israeli law and are typically less extensive than the disclosures of US domestic companies. Notwithstanding this fact, in its 2009 International Policy Update, RiskMetrics adopted a new compensation committee policy specifically directed toward US-listed Israeli foreign private issuers. Under the new policy, RiskMetrics recommends voting against the election of non-independent directors to the compensation committee of an Israeli foreign private issuer and, if the board does not have a compensation committee, RiskMetrics will recommend voting against non-independent directors serving on the board.8 Companies using the foreign private issuer compensation committee exemptions should consider the potential implications of doing so in light of RiskMetrics’s policy update.9
- Israeli companies should be aware of the increased use of derivative securities, such as total return equity swaps, by hedge funds and other activist shareholders. Large numbers of US companies have amended their bylaws (which generally only requires a board vote) to require shareholders seeking to nominate directors or propose other business at shareholder meetings to disclose in detail all derivative or other synthetic positions that they hold. Such positions can replicate the economics of holding a security of the company while the shareholder does not actually have voting or dispositive power of any securities. Israeli companies, whose shareholders would generally need to approve any amendment to their Articles of Association, have not taken similar steps to their US counterparts. At this point, we believe that boards of directors and management should simply be aware of this development.
- A small number of Israeli companies have adopted poison pills based on the models used by US companies. These poison pills are subject to Israeli law and the merits of adopting them or not need to be considered in light of the totality of Israeli law governing hostile acquisitions. Companies should consult with their US and Israeli counsel in order to obtain a perspective on poison pills.
- The compensation committees of US-listed Israeli companies should consider carefully the incentives that they are providing to management to complete a change-of-control transaction that the board considers to be in the interests of the company and its shareholders. Practices vary among Israeli companies with respect to single and double trigger change-of-control provisions in executive employment agreements.10 While single trigger change-of-control provisions have become less popular in the United States, many companies still provide for single trigger vesting for some or all benefits based on a belief that it is necessary to incentivize executives to complete a change-of-control transaction whether or not the executives are terminated. In addition, some companies want executives that remain with the company after a change-of-control to receive benefits that are similar to those benefits received by executives that are terminated.
Background to the Exemptions
NASDAQ Marketplace Rule 5615 allows foreign private issuers to follow their home country corporate governance practices without requesting a specific exemption from NASDAQ in lieu of the provisions of the Rule 5600 Series, Rule 5250(d), and Rules 5210(c) and 5255. There are a number of exceptions to the ability to opt out. First, each issuer must comply with the requirement to notify NASDAQ of any material noncompliance with its rules pursuant to Rule 5625. Second, such an issuer must have an audit committee that satisfies the functions set forth by the SEC as summarized in Rule 5605(c)(3). Third, members of such audit committee must meet the SEC’s criteria for independence. Fourth, a foreign private issuer must comply with NASDAQ’s direct registration program requirements under Rules 5210(c) and 5255 unless prohibited from complying by a law or regulation in its home country.
A foreign private issuer can choose to follow its home country corporate governance practice at any time during the fiscal year, provided that it submits to NASDAQ a written statement from an independent counsel in that company’s home country that certifies that the company’s practices are not prohibited by the home country’s laws. This certification must be submitted at the time the company first seeks to adopt a noncompliant practice. The company must then disclose in its next annual report those corporate governance rules that its does not follow, together with a brief description of its home country practices.
The opt out procedure for the NYSE generally parallels NASDAQ’s procedure.