Institutional Shareholder Services (ISS) recently announced that it will launch the updated version of its corporate governance risk and data screening tool, Governance QuickScore 3.0 (QuickScore), on November 24, 2014.1 QuickScore rates the corporate governance practices of the companies in the Russell 3000 Index and certain foreign companies.
ISS has opened its online data verification tool that can be accessed via ISS’ Governance Analytics website.2 Institutional investors may rely on a company’s QuickScore governance ratings when making proxy voting and investment decisions. As a result, public companies in the Russell 3000 Index should review the data ISS is using to determine their current QuickScore and provide any data corrections via ISS’ Governance Analytics website. Any data corrections must be provided by Friday, November 14, 2014 at 8 pm EST.
ISS portrays QuickScore as a tool that helps institutional investors identify and monitor potential governance risk in their portfolio companies and helps Russell 3000 companies identify possible investor concerns based on signals of governance risk reflected in their ratings in the system. The companies rated in QuickScore are scored on an overall basis and in each of four “pillars” – Board Structure, Compensation/Remuneration, Shareholder Rights & Takeover Defenses (formerly Shareholder Rights) and Audit & Risk Oversight (formerly Audit). Scoring is on a scale of 1 to 10, with 1 being the best score and representing the lowest level of governance risk. Scoring is relative to other U.S. companies in the subject company’s index (the Russell 3000 Index or S&P 500 Index for U.S. companies). The underlying QuickScore dataset for a company is updated on an ongoing basis as additional public disclosure regarding the company becomes available.
The scores will be included in the proxy voting recommendation reports ISS will issue on or after November 24, 2014. Scores will also be available on Yahoo! Finance, Bloomberg and NASDAQ Online, while QuickScore profiles are available through FactSet.
According to ISS, “[f]actors used to assess risk-related concerns for a given company…are based on the same principles that form the foundation of ISS’ global benchmark voting policy. … The QuickScore factor methodology is aligned with ISS’ benchmark proxy voting policy to ensure it is up-to-date and tailored to address appropriate variations in governance practices across global capital markets.”
Russell 3000 companies should review the data ISS is using to determine their current QuickScore and provide any data corrections by Friday, November 14, 2014 at 8 pm EST. In addition to verifying their data by November 14th, after the launch of QuickScore 3.0 on November 24th, companies can once again verify the underlying governance data that is used by ISS to formulate their QuickScore on an ongoing basis. However, companies cannot verify data between the filing of their proxy statement and the publication of ISS’ proxy analysis for the annual meeting. Once ISS’ proxy voting recommendations report for a company is released to institutional clients, the company may once again review their QuickScore data profiles and update/correct the data in their profile.
ISS has published a “how to” guide3 for reviewing data and providing feedback via ISS’ Governance Analytics website. ISS indicates that it will review and respond to any data changes. However, ISS will only consider a data correction request if it can verify the source of the corrected data through public filings (in the case of proxy statements, only definitive filings), website disclosures or press releases.
QuickScore 3.0 Updates
QuickScore 3.0 includes both new and amended factors for U.S. companies. See Exhibit A for the complete list of factors for U.S. companies.
New factors. QuickScore 3.0 adds the following factors for U.S. companies:
- Whether a company discloses a policy requiring an annual performance evaluation of the board. This factor examines not only whether a company organizes board evaluations, but also the nature of the evaluations (for example, frequency and individual and outside assessments). ISS believes the board, its committees and each director should be “regularly assessed” and that an assessment should consider (1) in the case of the board or a board committee, its mandate or charter, and (2) in the case of a director, the applicable position description(s) and the competencies and skills each director is expected to bring to the board.
- Whether ISS' review finds that the board recently took action that materially reduces shareholder rights. ISS notes that unilateral bylaw/charter amendments deemed material include amendments diminishing shareholder rights to call a special meeting or act by written consent, classifying the board, increasing authorized capital and lowering quorum requirements. Unilateral bylaw/charter amendments that have been recent “hot” topics among shareholder activists include exclusive forum selection provisions and fee-shifting provisions, although ISS does not specifically mention those topics in its commentary to this factor.
- Whether companies with an unequal voting structure have a sunset provision on the structure. ISS does not indicate the length of a sunset provision it will find acceptable.
- Whether the company has a controlling shareholder. ISS will consider whether a company has a shareholder or a group of shareholders acting in concert that holds a majority of the voting rights. This factor has a zero-weight impact on a company's QuickScore and is for informational purposes only.
Amended factors. ISS has updated the following existing factors for QuickScore 3.0:
- Whether a regulator has taken enforcement action against the company or a director or officer of the company in the past two years. The scope of the inquiry for this factor is now broader; the factor previously referred only to “securities” regulators. In addition to evaluating whether a company, director or officer was subject to an enforcement action (including, for directors and officers, enforcement actions related to employment or board service at other firms), ISS will also analyze if the investigation was resolved with a “material penalty.” When assessing the materiality of any penalties, ISS will consider the nature of the underlying investigation(s), the size of any monetary penalties (for companies, both on an absolute basis and relative to certain financial metrics, among which are revenues, earnings, cash flows and market value) and any non-monetary penalties or requirements. ISS will also consider settlement agreements, even if the company, director or officer denies the allegations underlying the investigation.
- Whether the board failed to address the issue underlying majority director withhold votes. ISS has added this to an existing factor—whether the board failed to implement a shareholder resolution supported by a majority vote. ISS will base its determination on whether a sufficient board response to the vote appears in disclosures in the proxy statement for the annual meeting following the annual meeting at which the majority withhold vote was cast.
- Whether the percentage of directors received shareholder approval rates below 80% of the votes cast at the most recent shareholder meeting. This factor previously referred to the “average level,” although the associated commentary indicated that ISS would evaluate the directors that received less than 95% shareholder approval.
- Whether the most recent say-on-pay proposal received shareholder support below 70% of the votes cast. This factor previously referred to the “industry-index level” without specifying a percentage.
- Whether the company’s average 3-year equity grant rate exceeds the greater of 2% and the average of its industry/index peers. This factor previously referred to the granting of equity awards “at an excessive rate, according to ISS policy.” However, the discussion of how ISS evaluated the previous factor appears consistent with how ISS will evaluate the amended factor.
Weighting changes. ISS will now score (i.e., they are no longer zero-weight factors and will thus impact a company’s QuickScore) the following factors: (1) gender diversity on the board and (2) the number of audit committee financial experts. For the last factor, ISS will evaluate whether a company has zero, one or two audit committee financial experts.
Report enhancements. QuickScore 3.0 reports will now include historical scores and a trending analysis reflecting how a company’s scores have changed over time.
Event-driven data updates. ISS indicates that it will proactively track changes to a company’s governance structure that are disclosed publicly, including in the company’s SEC filings and other publicly disclosed materials, and integrate those changes into the company’s QuickScore on a timely basis.
Impact of director disclosures on QuickScore. Of continuing concern for QuickScore ratings will be the independence classification of new directors (using ISS’ independence definition). ISS will monitor Form 8-K filings for new director disclosures, and if it is unable to make an independence classification of the new director based on the Form 8-K disclosures, it will consider the director “unclassified” until it has sufficient information to make an independence classification. In instances in which a new director is unclassified, a company’s board percentages, including board independence, committee independence calculations and percentage of directors that are family members or with related party transactions, are frozen at the calculated values based on the last complete disclosures and the company’s ratings on those factors will remain fixed. When all directors have been classified, ISS will update the calculation of such percentages to reflect the changes in classifications.
ISS considers the disclosure required by Section 5.02(d) of Form 8-K to be insufficient to permit it to determine if a new director is independent under ISS’ independence classification. ISS requires the following minimum information (perhaps in the form of a short biography) to enable it to make an independence classification of a new director, which information is less than what ISS required under the prior version of QuickScore:
- current position;
- the company’s determination of whether the director is independent under the listing standards applicable to the company;
- any previous employment at the company;
- any familial relationships with the company’s executives or directors; and
- any transactions (per Item 404(a) of Regulation S-K) between the director, the director’s employer, or the director’s immediate family member’s [sic] current employer, and the company in the last fiscal year.
These requirements go beyond those of Item 5.02(d) of Form 8-K regarding reporting the election of a new director outside of a shareholder meeting. In light of ISS’ position on classifying new directors, companies should consider including in any future Form 8-K they file to report the election of a new director outside of a shareholder meeting the ISS-required information about the new director. Depending on the timing of their appointment, directors elected outside of a shareholder meeting may be “unclassified” for almost a year, i.e., until the next proxy statement is filed, unless a company voluntarily provides the ISS-required disclosures.
Voting results. Certain data points are based upon the voting results from the previous shareholder meeting (for example, whether directors received shareholder approval below 80%). During the period of time between the issuance of the ISS proxy analysis and the publication of the shareholder voting results, these data points will be given a zero-weighting and will show in a company’s QuickScore profile as “pending.”
It remains questionable whether the complexities of corporate governance, particularly that of a specific company with its own set of particular, and sometimes peculiar, factors driving its governance choices, can be captured and properly reflected by numeric scores that are easily comprehensible and comparable across companies. This is especially so where the specific weighting and balancing of factors used to create a score are not clear. The difficulty of achieving such a goal with QuickScore is only compounded by the fact that scoring in the QuickScore methodology reflects ISS’ biases regarding whether particular corporate governance practices are salutary. However, as the scores will be published publicly and at least some institutional investors can be expected to rely on a company’s QuickScore when making voting and investment decisions, Russell 3000 companies should at least verify and, where necessary, correct the data ISS uses to create their QuickScores prior to November 14th and continuously thereafter once QuickScore 3.0 is launched.
Russell 3000 companies should also consider informing their boards and appropriate board committees about the updated QuickScore prior to their next meetings. However, boards and their committees should neither abdicate their business judgment nor ignore their fiduciary duties when evaluating and implementing governance and compensation practices and policies in order to obtain an acceptable QuickScore or other favorable ISS proxy voting recommendation.
Russell 3000 companies should also consider whether to take any actions related to QuickScore 3.0 in advance of filing their 2015 proxy materials. For example, companies may be able to improve their QuickScore by providing additional disclosure regarding certain factors (for example, the new factor regarding board performance evaluations) or disclosing governance practices that are already in place and that are responsive to QuickScore factors. To ensure that the new information is reflected in the QuickScore ratings reported in the ISS proxy voting report for a 2015 shareholder meeting, a company can either submit changes via the QuickScore data verification process before filing the proxy statement (if the changes are already reflected in publicly available information) or describe the changes in the proxy statement so that ISS will update the company's QuickScore accordingly during the course of preparing its proxy voting report.