Proxy advisory firms Institutional Shareholder Services Inc. (ISS) and Glass Lewis have both released their voting policies for the 2015 proxy season. The policy changes for U.S. companies include updates to the firms’ policies on shareholder voting on governance, compensation, environmental and social matters. ISS policy updates are effective for annual meetings held on or after February 1, 2015, while Glass Lewis policy updates are generally effective for annual meetings held on or after January 1, 2015. The policy changes are described below and are available by clicking the following links: ISS Updates and Glass Lewis Updates.
ISS Policy Updates
The ISS policy updates reflect the two proposed updates ISS had released in October. These proposed updates — independent chair shareholder proposals and a new equity plan scorecard for analyzing equity plans — were previously summarized in a prior blog, available by clicking here. The final policy guidelines also include updates to policies not proposed for comment by ISS. All of the changes are described below.
- Unilateral Bylaw/Charter Amendments
Bylaw/charter amendments adopted without shareholder approval are currently evaluated by ISS under its “Governance Failures Policy.” The new guidelines create a stand-alone policy for such unilateral amendments to codify ISS’ current application of its “Governance Failures Policy” as it relates to such amendments.
ISS will generally recommend a vote against or withhold from directors individually, committee members or the entire board if an amendment of the company’s bylaws or charter, implemented without shareholder approval, “materially diminishes shareholders’ rights” or “could adversely impact shareholders,” as determined by considering the following factors:
- the board’s rationale for not seeking shareholder ratification
- the company’s disclosure of any significant engagement with shareholders regarding the amendment
- the level of impairment of shareholders’ rights
- the board’s history of taking unilateral board action on bylaw/charter amendments or other entrenchment provisions
- the company’s ownership structure
- the company’s existing governance provisions
- whether the amendment was made prior to or in connection with the company’s IPO
- the timing of the amendment in connection with a significant business development
- other factors as ISS deems relevant to determining the amendment’s impact on shareholders.
- Independent Chair Shareholder Proposals
As ISS had proposed in October, it adopted revised guidelines for evaluating independent chair shareholder proposals. The updated guidelines add new governance, board leadership and performance factors to the analytical framework and require that all of the factors be considered in a holistic manner.
Under the current policy, ISS generally recommends a vote in favor of shareholder proposals for independent chairs unless the company counterbalances the combined chairman/CEO position with all of the following six criteria:
- the independent board members elect a lead director with clearly delineated and comprehensive duties
- at least two-thirds of the board is independent
- the key board committees are fully independent
- the company has established governance guidelines
- the company has not exhibited sustained poor “total shareholder return” (TSR) performance (defined as one- and three-year TSR in the bottom half of the company’s four digit industry group, unless there has been a change in the CEO position during such time)
- the company does not have any problematic governance issues.
Under the new policy, the current counterbalancing structure will be replaced with an analytical framework in which all of the following factors will be taken into consideration:
- the scope of the proposal; including:
- whether the proposal is precatory or binding
- whether the proposal seeks immediate change or change at the next CEO transition
- the company’s current board leadership structure:
- ISS may support proposals under the following scenarios absent a compelling rationale:
- presence of an executive or non-independent chair in addition to the CEO
- recent recombination of CEO/chair role
- departure from a structure with an independent chair
- ISS will also consider the effects of recent transitions in board leadership on independent board leadership, as well as the designation of lead director role
- ISS may support proposals under the following scenarios absent a compelling rationale:
- the company’s governance structure and practices, including:
- governance structure factors:
- independence of the overall board and of key committees
- establishment of governance guidelines
- director and CEO tenure
- any other relevant factors
- governance practices factors:
- poor compensation practices
- material failures of governance and risk oversight
- issues compromising director independence, such as related party transactions
- corporate or management scandals
- actions by management or the board with potential or realized negative impact on shareholders
- governance structure factors:
- company performance, assessed as follows:
- one-, three- and five-year TSR performance periods
- comparison of a company’s TSR as it relates to peers and market as a whole
- any other factors ISS deems relevant.
Under the new methodology, ISS will consider all the factors as a whole and a single factor that could have previously resulted in a particular recommendation might now be mitigated by the existence of other factors. Based on application of the new approach to 2014 shareholder proposals, ISS expects that the new methodology will result in a higher level of recommendations in favor of shareholder proposals for an independent chair.
- Litigation Rights
In its updated guidelines, ISS expanded its policy on bylaws with exclusive venue provisions (which typically require a shareholder to bring suit only in the company’s state of incorporation) to include other types of bylaws that have a material impact on the ability of shareholders to bring suit against a company, such as fee-shifting provisions that require a shareholder to pay all company litigation expenses when the shareholder is unsuccessful in its suit against the company.
Under the new policy, ISS will generally vote against proposals to adopt fee-shifting bylaws. For other bylaws provisions impacting shareholders’ litigation rights, ISS will vote case-by-case, taking into account factors such as:
- the company’s stated rationale for the bylaws provision
- disclosure of past harm from shareholder lawsuits in which plaintiffs were unsuccessful or shareholder lawsuits outside the jurisdiction of incorporation
- the breadth of application of the provision, including the types of lawsuits to which it would apply and the definition of key terms
- governance features such as shareholders’ ability to repeal the provision at a later date and their ability to hold directors accountable through annual director elections and a majority vote standard in uncontested elections.
- Equity Plan Scorecard
As proposed by ISS in October, this updated voting policy uses a “scorecard” evaluation model that considers a range of positive and negative factors in determining whether to give a negative recommendation rather than relying on the series of “pass/fail” tests applied in the existing policy. While some egregious factors will continue to result in a negative recommendation regardless of other positive factors, consideration of all of the scorecard factors will allow for a more holistic methodology in determining whether a “For” or “Against” recommendation is warranted.
The scorecard factors will fall under one of three pillars as follows:
Plan Cost: The total potential cost of a company’s plans relative to industry/market cap peers, measured by the company’s estimated “Shareholder Value Transfer” (SVT) in relation to its peers. SVT would be calculated for both (i) the sum of new shares requested, shares remaining for future grants and outstanding unvested/unexercised grants and (ii) the sum of new shares requested plus shares remaining for future grants. This dual cost approach would eliminate ISS’ current option overhang carve-out policy.
Plan Features: Automatic single-triggered award vesting upon a change in control; discretionary vesting authority; liberal share recycling on various award types (this would eliminate liberal share recycling from SVT calculations); and minimum vesting period for grants under the plan.
Grant Practices: The company’s three-year burn rate relative to industry/market-cap peers (this would eliminate company burn rate commitments); vesting requirements of most recent CEO equity grants (3-year look-back); estimated duration of the plan based on annual grant practices and shares remaining available plus new shares requested; proportion of the CEO’s most recent equity grants subject to performance conditions; the existence of a clawback policy; and the existence of post exercise/vesting share retention requirements.
If the combination of the above factors indicates an equity plan is not in the shareholders’ interest, ISS will recommend a vote against approval of such equity plan. Moreover, the existence of any of the following factors (regardless of a plan’s scorecard rating), will result in a negative recommendation by ISS: (i) vesting of awards in connection with a liberal change-of-control definition; (ii) ability to reprice or buyout underwater options without shareholder approval; (iii) the plan is a means for problematic pay practices or pay-for-performance disconnect; and (iv) any other plan features with a significant negative impact on shareholder interests.
Scorecard factor weightings and burn-rate benchmarks factors will be keyed to a company’s size and status (i.e., S&P 500, Russell 3000 (excluding S&P 500), Non-Russell 3000, and recently completed IPOs or bankruptcies). For S&P 500 and Russell 3000 companies, the pillars will be weighted as follows: 45 percent (plan cost), 35 percent (grant practices), and 20 percent (plan features). ISS will provide more information about the scorecard and weightings in its Compensation FAQ to be published in December.
ISS has stated that the scorecard approach is not designed to increase the number of negative recommendations ISS issues even though it is designed to expand the number of factors that investors may consider in determining whether an equity plan serves their long-term interests.
- Environmental and Social Issues
The new guidelines also update two ISS policies on environmental and social issues. ISS will continue to generally vote in favor of proposals requesting greater disclosure of political contributions and trade association spending policies and activities, but this policy was refined to indicate separately the factors ISS considers regarding board and management oversight and indirect political contribution activity and to expand the type of disclosure that ISS will consider. With respect to its policy on greenhouse gas emissions, ISS revised the factors it considers in its case-by-case approach to proposals calling for the adoption of greenhouse gas reduction goals from products and operations. Specifically, ISS will no longer consider whether a shareholder proposal is overly prescriptive nor the feasibility of emissions reductions but has expanded its disclosure requirements.
Glass Lewis Policy Updates
Similar to ISS, the updated Glass Lewis voting policies focus on governance-related policies as they relate to actions which diminish shareholder rights.
- Governance Committee Performance
Glass Lewis has added to its policy recommending that shareholders vote against the chairman of the governance committee, or the entire committee, when the board amends the company’s governance documents without shareholder approval in a manner that “reduce[s] or remove[s] important shareholder rights” or “impede[s] the ability of shareholders to exercise such right.” Examples of such board action include:
- eliminating the shareholders’ ability to call a meeting or act by written consent
- increasing the ownership threshold for calling a meeting
- increasing the vote requirement for amending governing documents
- adopting provisions that limit shareholders’ litigation rights (such as fee-shifting provisions)
- implementing a classified board
- eliminating the shareholders’ ability to remove directors for cause.
Note that Glass Lewis’ current policies already include a policy to vote against the governance committee chair for unilateral bylaws amendments to add exclusive forum clauses.
- Board Responsiveness to Majority-Approved Shareholder Proposals
Glass Lewis also adopted a policy to generally recommend a vote against all members of a governance committee where a board has not begun to implement the subject matter of certain shareholder proposals that have been approved by a majority of the votes cast (excluding abstentions and broker non-votes). Examples of such shareholder proposals include proposals calling for:
- a declassified board
- a majority vote standard for director elections
- a right to call a special meeting.
- Vote Recommendations Following IPO
While Glass Lewis generally does not issue vote recommendations on governance best practices matters for the one-year period following an IPO, it has updated its voting policies to reflect increased scrutiny over certain provisions in a company’s governance documents that were implemented prior to the company’s IPO and not put to a shareholder vote post-IPO, including recommending a vote against:
- all members of the board who adopted anti-takeover provisions (such as a poison pill or classified board)
- the governance committee chair where exclusive forum bylaw provisions were adopted
- the entire governance committee where fee-shifting bylaw provisions were adopted.
- Other Voting Policy Changes
In addition to the above new policies, Glass Lewis has implemented certain clarifying changes to the following existing voting policies:
- “Material” Transactions With Directors: Glass Lewis has clarified that where a company pays a professional services firm employing a director and the fees paid represent less than 1 percent of the firm’s revenues, it may consider such a transaction to be immaterial for purposes of determining a director’s independence, notwithstanding the amount of such fees exceeding $120,000; provided the company provides a compelling rationale as to why such director’s independence is not compromised by such relationship.
- Advisory Vote on Executive Compensation: The updated voting policies clarify Glass Lewis’ approach on qualitative and quantitative say-on-pay analysis and describe its approach to analyzing one-off awards granted outside of a company’s existing equity plans. It is Glass Lewis’ general position that one-off awards should be disfavored over redesigning a company’s compensation plans. However, in the instance where one-off awards are appropriate, Glass Lewis believes that companies should provide thorough disclosure of such awards, including the rationale for granting such awards.
- Employee Stock Purchase Plans: Glass Lewis has added further guidance on its approach to analyzing employee stock purchase plans, including its quantitative model for estimating a plan’s cost as compared to similar companies. In addition, plans which contain evergreen provisions to automatically increase the number of shares available under the plan will generally receive a negative recommendation.