“Proxy season” is stretching longer and longer with each passing year as the “off season” has become the season to engage with institutional shareholders and to prepare for the next season. With 2014’s annual meetings now largely completed and the 2015 proxy season on the horizon, now seems a good time to review lessons learned and themes from 2014. This Corporate Governance Update addresses some of the developments that shaped the proxy season in 2014 and discusses points worth considering as preparations for the 2015 season begin.
Disclosure: Going Beyond What is Required?
Since the advent of mandatory say-on-pay votes in 2011, public companies have increasingly focused on making their proxy statements more readable and persuasive to investors, and the 2014 proxy season saw an acceleration of this trend, particularly at the largest public companies. This trend includes a renewed focus on disclosing information that is not otherwise required to be disclosed by the proxy rules, presenting information in eye-catching ways, engaging investors directly and being more responsive to their requests for information. While none of this is required or universal or in some cases even particularly common, some of the steps we have seen companies take include:
- Sophisticated visual and graphic presentations similar to the glossy annual report – extensive use of charts and graphs and flow-charts to illustrate information such as company financial performance and board committee membership
- Letter to shareholders from the CEO about governance – no longer just the notice of meeting signed by the corporate secretary
- Letter to shareholders from the Board of Directors about their views on governance – perhaps the only time during the year that the Board of Directors speaks publicly as a Board
- Summary of business results or business highlights in the CD&A – to connect the dots between pay and performance
- Summary of the CD&A – because the new supplemental charts and graphs and flow-charts can have the effect of lengthening disclosures that are in many instances already way too long for the average investor
- Realized/realizable pay disclosure – institutional investors want this information and don’t want to wait for the SEC to propose and adopt Dodd-Frank Section 953’s disclosure requirement on the relationship between actual compensation and financial performance
- W-2 disclosure – to show actual “take home” pay, which in many cases is lower than the SEC-mandated total compensation amount
- Disclosure about efforts to engage with shareholders – in part, prompted by ISS, which has stated that it will consider, as a factor in developing its vote recommendations for companies that received a sub-70% approval vote, the company’s disclosures regarding shareholder engagement
As companies begin to contemplate the 2015 proxy season, one question for companies is whether they should devote the resources to revise their proxy disclosures to include sophisticated visual and graphic presentations of information as several of the largest public companies have done, as doing so may require professional assistance from graphic design firms. Aside from the expense of this type of assistance, it should be noted that one reason why institutional investors use proxy advisory firms such as ISS is because ISS uses a standardized form of report, which institutional investors are said to prefer for efficiency’s sake, given the vast volume of votes they cast during the proxy season.
Whether or not companies choose to use graphic design as another means to engage, educate and persuade investors to vote for their director nominees and in favor of the compensation paid to their executive officers, this general trend of making proxy statements more readable and persuasive will likely continue for the near term. And, once the SEC implements the Dodd-Frank required rulemakings on pay ratio and pay for performance, we can expect companies to provide even more information to investors to situate the newly required information in a context that casts them in a favorable light.
The Threat of Litigation
The threat of proxy statement-related litigation is another recent trend that continued into 2014. As in past years, these threats arise most frequently in connection with compensation plan proposals and, in our experience, fall into one of two categories. The first type of threat is generic, in which a company receives what amounts to a form letter from a plaintiff’s law firm, claiming that the plan proposal included in a company’s proxy statement is inadequate because it does not include a long litany of items described in the letter. The second type of threat is individualized and specific to the company’s disclosures. It relates to proposals for equity or cash compensation plans that are designed so that some portion of what is paid thereunder will qualify as “performance-based” compensation for Section 162(m) purposes. The lawyers principally responsible for these threats individualize their letters, focusing closely on the precise language used in the proposal and the plan, looking for perceived inconsistencies between the two or between what is proposed and the requirements of Section 162(m).
Not all compensation-related litigation falls neatly into one of these two categories. One notable exception is a recent suit claiming that a Delaware corporation had misapplied the vote standard under its bylaws and Delaware law in concluding that its stockholders had approved an increase in the share reserve under an equity plan at the prior year’s annual meeting.
Although these suits, and threats relating thereto, are often ultimately inconsequential, they can still cause disruption and distraction. Accordingly, companies preparing a 2015 proxy statement that will include a plan proposal may want to assess what can be done to reduce the likelihood of this type of litigation. One positive development for companies in this area is that the Delaware Chancery Court recently re-affirmed the rule that merely bringing to the company’s attention a purported proxy disclosure deficiency that is then corrected will not give rise to a claim for attorneys’ fees unless the claim is meritorious (i.e., if it had been brought before a court, it would have survived a motion to dismiss).
For companies intending to seek stockholder approval of a compensation plan, we recommend that they be fastidious with regard to compliance with SEC disclosure requirements and plan descriptions. The only time these suits seem to be of any consequence is when there has been some perceived error or inaccurate description of the plan in the plan proposal. We also recommend that companies consider whether to include any plan-related information, beyond the minimum required by SEC disclosure rules, in the proposal. For example, many companies include burn rate information in their equity plan proposals. This can be useful in defending the proposal to investors and institutions such as ISS, and it might also have an ancillary benefit of causing plaintiff’s firms to direct their attention elsewhere. Finally, we recommend that in-house counsel notify directors and senior management in advance that a plan proposal, no matter how well-executed, may very well draw “investigations,” threatening letters and even actual lawsuits. Lawyers tend to understand that all of this is just par for the course now, but board members and senior officers sometimes conclude that there is cause for alarm.
Tax Considerations Disclosures – One Specific Disclosure Suggestion
For many years, a stand-alone section on “Tax Considerations” has been a standard feature of the CD&A. These sections typically focus on Section 162(m) considerations and contain generic statements regarding the desire to maximize tax efficiency while also retaining the need for flexibility. In 2014, some companies omitted these sections. Deletion seems advisable in many instances, particularly given that these sections (i) have sometimes been targeted by plaintiff’s firms, (ii) are generally little more than boilerplate and (iii) rarely contain any material information (and thus are not required to be disclosed under Item 402(b)(2)). Companies wishing to streamline and focus their CD&A on meaningful disclosures may wish to consider doing the same.
Consistency on Say-on-Pay
Say-on-pay votes continue to be a major focus of public companies and their boards. To a large extent, the focus on presentation, engagement and readability has been a direct outcome of the say-on-pay proposal’s inclusion on the proxy ballot.
From our perspective, what may be most interesting about say-on-pay during the 2014 proxy season was just how similar it was to 2013, and to 2012 for that matter. According to statistics assembled by Semler Brossy, the percentage of companies that had failed votes (2.4% in 2014), the frequency with which ISS recommended a vote against (13% in 2014), the average level of support (91% in 2014) and the average “swing” (approximately 29% in 2014) associated with an ISS recommendation either way have all been remarkably consistent year-over-year.
Notwithstanding that the averages have largely stayed the same, the roster of companies that have failed or received an adverse vote has, of course, changed substantially each year. In many instances, an adverse ISS vote recommendation does not lead to a failed vote, but it does have the potential to create a significant distraction for management and the board. It can also contribute to an understanding that changes are advisable in the company’s compensation program. When an adverse ISS vote recommendation leads to a vote below 70%, the pressure to make compensation changes becomes more pronounced, as 70% is the threshold below which ISS has indicated that it will pay particular attention to a company’s response to the vote in assessing whether to recommend a vote against the company’s say-on-pay proposal or compensation committee member elections in the following year.
While it will likely be difficult to change an ISS vote recommendation once it is made, it can be helpful, if for no other reason than setting expectations, to have some sense in advance as to the likely recommendation. Most compensation consulting firms are able to replicate, to some extent, the ISS modeling in order to make a prediction regarding ISS vote recommendations. Companies that do not already do so may wish to ask their compensation consultants to run such a model as part of their proxy preparation process.
Proposals Past, Present and Future
2014 was largely an unremarkable year with respect to Rule 14a-8 stockholder proposals. While there were certainly numerous proposals submitted and several spirited battles over the exclusion of some of those proposals, the Staff did not issue any new rules or major interpretive positions in this area during the year. Most of the proposals covered familiar topics, and there were no substantively ground-breaking no-action letters from the Staff.
That being said, there are still lessons to be learned from the 2014 proxy season. First, there was noticeable continuity between 2013 and 2014 in that most of the proposals submitted this year related to the same or similar topics that accounted for most of the proposals submitted in 2013. The most frequently submitted proposals related to corporate political spending, with approximately 85 of such proposals having been voted on in the first half of 2014 according to SharkRepellent.net, just slightly down from the totals for the first half of 2013. Governance-related proposals mostly related to topics that have been the subject of Rule 14a-8 proposals for several years. These include proposals that would (i) require an independent chair, (ii) give stockholders the right to act by written consent, (iii) give stockholders the right to call a special meeting, (iv) require a majority vote standard for uncontested director elections, or (v) implement a form of proxy access. Other than with respect to majority voting, the average support for these governance-related proposals was less than 50% in 2014. As many companies adopt forms of these governance practices, the proportion of governance-related proposals has continued to decrease in comparison to proposals related to social issues. In addition to corporate political spending, proposals on environmental protection and human rights remained common, and certain hotly contested issues in the news, such as those related to cyber-security and data privacy, have emerged as important topics of social policy-driven proposals.
Notwithstanding the familiarity of most of the proposals submitted in 2014, there were a few proposals submitted to a number of companies that were noteworthy for being either entirely new or a novel approach to a proposal from a prior year. The first, although not entirely new, was a proposal that would prohibit single trigger vesting of equity awards upon a change in control. This type of proposal was submitted to 21 companies, and, somewhat surprisingly, five such proposals garnered majority support. Another interesting proposal that emerged in 2014 related to the sharing of interim vote tallies, sparked by the voting campaign at JPMorgan’s annual meeting in 2013. The proposal was intended to bar management from receiving voting information on ballot items prior to the annual meeting. Several companies were able to have this proposal excluded, but it went to a vote at five companies, where it was soundly defeated each time.
One final note regarding Rule 14a-8 stockholder proposals is more procedural than substantive. In the 2014 proxy season, there was an increase in the number of companies that elected to go to federal court rather than submit no-action requests to the Staff of the Division of Corporation Finance to exclude stockholder proposals under Rule 14a-8. While these companies generally achieved the goal of not having to include these proposals in their proxy statements, this approach involves more time and expense than the traditional SEC no-action process.
Long something of a discussion point, director tenure emerged as a significant issue in 2014 and is certain to remain front and center in 2015. Two developments in particular contributed to the emergence of the issue. First, ISS added director tenure as one of five new governance factors that it will consider when calculating a company’s QuickScore. In its commentary, ISS indicated that it will consider the proportion of directors who have served on the board longer than nine years, which ISS deems “excessive” as it may potentially compromise a director’s independence. At the same time, ISS has identified director tenure as one of several points that it has included in its policy outreach during 2014, raising the possibility that tenure consideration could be the subject of a new ISS voting policy for the 2015 proxy season and/or beyond. The second development was the adoption by State Street Global Advisors (“State Street”) of a director tenure policy that it will apply at the companies in which it holds a position. Under the policy, State Street may vote against long-tenured directors and/or nominating committee members at its investee companies if State Street feels that the company is in need of “board refreshment.” State Street considers a director “long-tenured” if the director’s tenure is more than two standard deviations above the average market-level board tenure.
Given these developments, director tenure is a significant issue that we are following as we begin to think about the 2015 proxy season. Just how much of an issue this becomes will be influenced in significant part by whether ISS adopts a voting policy regarding director tenure and, if it does, what the policy says. While it seems unlikely that many boards will make changes to their board composition based solely on an ISS voting policy, the increasing focus on the issue could very well cause subtle changes in the thinking and actions of nominating committees and may lead to an increased reluctance to renominate long-tenured directors without a thoughtful consideration of their past, and potential for future, contributions.
The SEC expects to address some overdue rulemaking this Fall as mandated by the corporate governance and executive compensation provisions of the Dodd-Frank Act. Specifically, the SEC issued a semiannual regulatory agenda indicating that it plans to adopt the pay ratio disclosure rules in final form by the end of October 2014. The regulatory agenda suggests that the SEC also expects to propose rules by then addressing (i) disclosure of pay-for-performance, (ii) mandatory policies and disclosure about clawbacks of executive compensation and (iii) disclosure of hedging by employees and directors. Even if the rules are adopted or proposed in this timeframe, they will not compel disclosure in 2015 proxy statements.
Proxy Advisor Regulation
Earlier this summer, the SEC put out a series of FAQs regarding proxy advisers. The FAQs focused on the interaction between investment advisers and proxy advisers such as ISS. A link to the Sidley memo relating to these FAQs is here.
While the 2014 proxy season was relatively quiet, it provided a few lessons to keep in mind when preparing for next year. Companies that intend to include a compensation plan proposal on the ballot next year should draft such proposals very carefully, taking into account the types of disclosure (or lack thereof) that plaintiff’s firms targeted this year. All companies, even those where the say-on-pay proposal has easily passed in past years, should review their compensation programs and disclosure, engage with stockholders and pay attention to relevant proxy advisory firm policies in preparation for their next say-on-pay votes. Companies should also continually monitor their corporate governance and business practices to determine where they might be vulnerable to stockholder proposals.