On November 21, 2013, Institutional Shareholder Services Inc. (ISS) issued its Canadian Corporate Governance Policy 2014 Updates (the 2014 Updates) applicable to shareholder meetings of TSX and TSX-V issuers held on or after February 1, 2014. This year, ISS addresses the following key issues: enhanced quorum by-laws, persistent problematic audit-related practices, board responsiveness to shareholder actions, director independence, over-boarding and attendance, and director and executive compensation.
Recommendations of ISS and other proxy advisory firms can have a substantial effect on the outcome of shareholder meetings, particularly for issuers with a significant institutional investor shareholder base. Issuers are advised to review the 2014 Updates with their advisors and legal counsel to avoid any potential negative voting recommendations at their upcoming meetings. A full set of the ISS Canadian policies will be published in December 2013.
Summary of 2014 Updates
New ISS Policies
- Board Responsiveness ISS states that a lack of board response to shareholder majority votes or majority withhold votes cast in respect of a director is unacceptable. ISS will generally recommend WITHHOLDING voting for current directors if the company has failed to address the issues that caused a majority withhold vote, or has failed to act on majority shareholder supported proposals.
- Enhanced Quorum Requirements for Contested Director Elections ISS will generally recommend voting AGAINST new or amended by-laws that establish two different quorum levels that result in a higher quorum being required for a meeting where a majority of the current board is sought to be replaced. Shareholder votes should carry equal importance, and therefore all matters of business should be approved at meetings with the same shareholder quorum requirement.
- Persistent Problematic Audit-Related Practices (TSX issuers only) ISS will recommend WITHHOLDING votes on a case-by-case basis for the re-election of the current members of the Audit Committee and potentially the full board of directors if adverse accounting practices are identified that have risen to a level of serious concern. Examples of such practices include accounting fraud, misapplication of applicable accounting standards or material weaknesses in internal control processes. The severity, breadth, chronological sequence and duration of such issues and the issuer’s efforts at remediation will be considered in making the recommendation.
Updates to Existing ISS Policies
Shareholder Rights and Defenses
- Advance Notice Requirements ISS will recommend voting AGAINST advance notice by-laws or policies: (i) if the board does not have the ability to waive the entire advance notice provision; or (ii) in instances where the company requires proposed director nominees to deliver a written agreement acknowledging that they will comply with all company policies and guidelines applicable to directors.
- Director Over-boarding and Attendance Policy (TSX issuers only) ISS has amended its over-boarding policy to combine the concept of over-boarding with a director’s attendance at board or committee meetings. ISS is of the view that this double-trigger policy is more appropriate for the Canadian market than the current practice of relying solely on the definition of over-boarding. A director will be over-boarded if he or she falls within the definition of over-boarding and has attended less than 75% of his/her respective board/committee meetings held within the past year without a valid reason (irrespective of whether the company has a majority voting policy).
A director is over-boarded if the director is:
- a CEO of a public issuer and sits on more than two outside public company boards; or
- a non-executive director who sits on more than six public company boards in total.
ISS will generally recommend a WITHHOLD vote for such director nominees. In its attendance policy, ISS will recommend a WITHHOLD vote for directors who, whether or not the company has adopted a majority voting policy, have attended less than 75% of the board/committee meetings held within the past year without a valid reason.
- Definition of Director Independence ISS has amended its criteria for identifying “inside directors,” “affiliated outside directors” and “independent directors” in its policy on the election of directors at uncontested meetings. The amended criteria specifically addresses the status of interim executive board members, a former CEO of the issuer or an affiliate.
- Voting on Directors for Egregious Actions ISS has maintained its current recommendation to, under extraordinary circumstances, WITHHOLD voting for individual directors, committee members or the entire board due to material failures of governance, stewardship, fiduciary responsibilities or risk oversight. The 2014 Updates identify the following examples of failure of risk oversight: bribery, large fines or sanctions, significant adverse legal judgments or any amount of hedging of company stock. Hedging activities by executives and directors that are permitted by a company are explicitly considered a material risk oversight failure.
Director and Executive Compensation
- Non-Employee Director Participation in Equity Compensation Plans (TSX issuers only) The 2014 Updates increase the non-employee director permitted value limit on forms of equity (other than stock options) granted to such directors. There are now different limits for option-based and share-based (non-option) equity compensation awards.
ISS will generally recommend voting AGAINST an equity compensation plan where:
- the aggregate share reserve under the plan for non-employee directors exceeds one percent of the outstanding common shares; or
- the plan does not specify an annual individual non-employee director grant limit with a maximum value of: (i) $100,000 worth of options under a stock option or omnibus plan; or (ii) $150,000 worth of shares under an equity plan that does not grant stock options.
ISS generally recommends voting AGAINST individual equity grants to non-employee directors when:
- ISS is already voting against the underlying plan that is being considered at a meeting; and
- if the director’s annual grant would exceed the limits above.
- Stock Option Repricing Proposals The 2014 Updates remove the exception under which ISS previously would have approved an option exchange proposal or a repricing of outstanding options. ISS will generally recommend voting AGAINST a repricing of stock options, including the following adjustments that can reasonably be considered repricing: reduction in exercise price or purchase price, extension of the term of outstanding options, cancellation and reissuance of options and substitution of options with other awards. The extension of option terms is also not acceptable to ISS.
- CEO Pay for Performance Evaluation – Changes to Quantitative Screen Metrics for Relative Degree of Alignment (RDA) (TSX issuers only) ISS determines long-term pay for performance alignment using a two-step process:
- a quantitative screen that includes relative and absolute analysis on pay for performance based on total shareholder return and other defined metrics; and
- a qualitative assessment of the CEO’s compensation and overall company performance.
The 2014 Updates revise the methodology used to calculate RDA. RDA will be calculated as the difference between the issuer’s annualized Total Shareholder Return rank and the CEO’s annualized total pay rank within its peer group, equally measured over a single three-year period. Previously, RDA was the weighted average of the one-year and three-year RDA. ISS is of the view that a single three-year measure better aligns with its stated principles of evaluating long-term shareholder performance.
- Board Communication and Responsiveness Related to Executive Pay (TSX issuers only) ISS will specifically consider the failure of an issuer to respond to a say-on-pay proposal that received support of less than 70% of votes cast when evaluating its executive pay. ISS will look to enhanced disclosure of engagement efforts regarding the issues that contributed to the low levels of support and the specific actions taken by the company to address such issues in making its recommendations. ISS states that a vote below 70% but above 50% is seen to be representative of substantial shareholder dissatisfaction with a company’s executive compensation structure, practices or disclosure.
ISS ongoing public consultation
For the first time, ISS announced it will publicly consult on long-term policy changes beyond the scope of the 2014 proxy season updates. This reflects a shift in ISS’s focus on governance from specific seasonal guidance to a continuous review of policy development over the year. The first public consultation period closes in February 2014. The topics open for comment during this first consultation period applicable to Canadian issuers are director tenure and equity-based compensation plans.
Copies of the 2014 Updates and related documents can be accessed below:
- Institutional Shareholder Services Inc. Canadian Corporate Governance Policy – 2014 Updates (pdf 765kb) – November 21, 2013
- Institutional Shareholder Services Inc. 2014 Canadian Corporate Governance Policy Updates and Process – Executive Summary (pdf 419kb) – November 21, 2013.