Updates for U.S. Companies in 2017 Include Negative Director Recommendations for Dual-Class IPO Companies and Implementation of Tougher Overboarding Restriction


Yesterday, Institutional Shareholder Services, the proxy advisory firm, announced updates to its benchmark proxy voting policies applicable to meetings held on or after February 1, 2017. For U.S. companies, the updates provide for negative vote recommendations for:

  • directors at newly public companies that have classes of stock with unequal voting rights, or that have other materially adverse provisions (such as supermajority voting requirements), absent a reasonable sunset provision;
  • directors at companies that impose undue restrictions on shareholders' ability to amend the company's bylaws (relevant in the few states, including Maryland, that permit such restrictions); and
  • non-CEO directors who hold more than five public company board seats (down from six under current policy).

ISS also made largely technical changes to its policies on share authorization requests and on equity plan approvals, including the addition to the equity plan scorecard of payment of dividends prior to vesting and clarification of how its policies apply to proposals seeking approval solely for Section 162(m) purposes.

Finally, ISS adopted a new policy to evaluate management proposals to ratify non-employee director pay programs (which are rare), and a clarification and broadening of the policy to evaluate non-employee director equity plans. While these are not broadly impactful changes for U.S. companies, they may signal a growing focus of ISS on director compensation generally, especially when viewed together with a broad new policy on problematic director compensation practices at Canadian companies.


Newly Public Companies With Dual Classes of Stock With Unequal Voting Rights

ISS's current policies relating to IPO companies result in a negative vote recommendation for director nominees where, prior to or in connection with the IPO, the board adopted provisions materially adverse to shareholder rights, unless the company commits to put the provision to a shareholder vote within three years. ISS has most commonly applied this policy to situations where the company went public with supermajority voting provisions.

Citing an increase in the number of companies completing IPOs with multi-class capital structures, ISS has amended this policy to specifically provide for a negative vote recommendation at newly public companies with a multi-class capital structure in which the classes have unequal voting rights. Unless the adverse provisions are removed, ISS will vote case-by-case on director nominees based upon a consideration of several factors, including the level of impairment of shareholders' rights, the disclosed rationale, the ability to change the governance structure and any reasonable sunset provision. The commitment to put an adverse provision to a shareholder vote within three years will no longer impact the recommendation.

Restriction on Shareholder Right to Amend Bylaws

The updates include adoption of a new policy regarding shareholders' ability to amend the company's bylaws. ISS regards the ability of shareholders to amend a company's bylaws as "a fundamental right" and noted that some states permit companies to restrict this right in their charters. Maryland is one example of such a state. The new policy results in a negative vote recommendation for members of a company's governance committee if the company's charter imposes undue restrictions on shareholders' ability to amend the company's bylaws. Examples of undue restrictions include outright prohibitions on the submission of binding shareholder proposals and share ownership and time holding requirements more onerous than the requirements under SEC Rule 14a-8 (that is, $2,000 of stock held for one year). ISS will issue negative director vote recommendations on an ongoing basis until the undue restrictions are removed.

Director Overboarding

As previously announced,1 ISS lowered the number of board positions it considers acceptable for directors who are not currently public company CEOs from six public company boards in total to five public company boards (the board under consideration plus four others). In doing so, ISS included a oneyear grace period to give directors the opportunity to come into compliance with the lower limit. The oneyear grace period is ending and, effective for meetings on or after February 1, 2017, ISS will issue a negative vote recommendation for overboarded directors under the revised policy.

ISS has not changed the threshold at which a public company CEO will be considered overboarded. That threshold remains at two public company boards, other than the CEO's own company, and any resulting negative recommendation will apply only to directorships other than the CEO's own company.

Proposals to Approve Increased Shares Authorization

The updates include clarifying changes to ISS's common stock authorization policy, which previously did not clearly address the treatment of the part of an increase necessary to effect a stock split or stock dividend. The revised policy changes "increase" to "effective increase" to make clear that the changes solely to implement the split or dividend do not affect the analysis.

Proposals to Approve or Amend Equity-Based Plans

ISS made largely technical amendments relating to proposals to approve or amend equity-based compensation plans. ISS uses an "equity plan scorecard" approach with three pillars to evaluate and provide vote recommendations in respect of these plans. ISS added a new factor to the "plan features" pillar--whether dividends are payable prior to award vesting. According to ISS, dividends should only be paid on awards after they have been earned, not while they remain subject to service or performance requirements. As such, ISS will award full points under this new factor if the equity-based compensation plan expressly prohibits the payment of dividends in respect of unvested awards and applies to all awards. Note that it is acceptable to accrue dividends in respect of unvested awards as long as they are payable only on vesting.

ISS also modified the minimum vesting factor. To receive full points on this factor, the plan under consideration must provide for a minimum vesting period of one year for all award types which cannot be eliminated or reduced in individual award agreements, except for up to 5% of shares issued under the plan.

ISS also reorganized its cash and equity plan amendments policy to clarify the framework for evaluating different plan amendment proposals. The clarifications generally recommend voting case-by-case on such amendments. The policy also describes limited scenarios in which the evaluator can dispense with the case-by-case analysis and recommend a "for" and "against" vote. For example, ISS recommends a vote against a proposal seeking approval solely for Section 162(m) purposes submitted by companies with compensation committees that are not composed exclusively of outside directors.

Director Compensation

Finally, ISS updated its policies to address non-employee director (NED) compensation in a number of minor ways. According to ISS, due to a number of high-profile lawsuits alleging excessive NED compensation and greater shareholder scrutiny on the topic overall, ISS has evaluated several management proposals seeking shareholder ratification of its NED pay programs and decided to implement a new policy to evaluate such proposals. In our experience, stand-alone proposals on director compensation are rare, though an increasing number of companies are including limits on director compensation in their omnibus plans in light of the litigation noted above.

Under the new policy, ISS will assess eight qualitative factors, including the magnitude of the pay program as compared to similar companies, problematic pay practices, the structure of the pay program (cash/equity mix, equity vesting schedules, retirement benefits and perquisites), the presence of meaningful limits of NED compensation and the disclosure around the pay program. ISS also implemented corresponding changes to its existing policy for evaluating NED-specific stock plans; these changes do not appear to impact the assessment of omnibus stock plans even if they provide for, and/or include limits on, NED compensation.

While these changes are not likely to be broadly impactful for U.S. companies, they may signal a growing focus of ISS on director compensation generally, especially when viewed together with ISS's broad new policy on problematic director compensation practices at Canadian companies. ISS's new Canadian policy provides for negative recommendation for directors at companies with problematic director compensation pay practices, such as excessive inducement grants and the use of performance-based equity awards.