Gibson Dunn Discusses Proxy Advisers’ 2017 Voting Guidelines

The two most influential proxy advisory firms–Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis)–recently released their updated proxy voting guidelines for 2017.  The key changes to the ISS and Glass Lewis policies are described below along with some suggestions for actions public companies should take now in light of these policy changes and other proxy advisory firm developments.  The 2017 ISS policy updates are available here.  The 2017 Glass Lewis Guidelines are available here.

ISS 2017 Proxy Voting Policy Updates

On November 21, 2016, ISS released updated proxy voting policies for shareholder meetings held on or after February 1, 2017.  These policies are used by ISS in making voting recommendations on director elections and company and shareholder proposals at U.S. companies.  The changes in the 2017 proxy voting guidelines are described below.

ISS also indicated that it plans to issue updated FAQs on equity plan proposals (discussed below) and other matters in mid-December, and that it plans to issue updated voting policies on shareholder proposals anticipated for 2017 annual meetings in January 2017.

Director Elections

Overboarded Directors 

As announced in the ISS 2016 Proxy Voting Policy Updates, ISS will begin recommending votes “against” directors who sit on more than five public company boards.  Prior to this announcement and during the 2016 transition period, the maximum number of boards a director could sit on without receiving a negative ISS voting recommendation was six.  The recommendations for public company CEOs remain unchanged:  ISS will continue to recommend votes “against” public company CEOs who sit on the boards of more than two public companies besides their own (but only at those companies where the CEO is a director, not on the CEO’s own board).

Restrictions on Shareholders’ Ability to Amend Bylaws

ISS now will recommend votes “against” members of the governance committee if a company’s charter places “undue” restrictions on shareholders’ right to amend the company’s bylaws.  Undue restrictions include, but are not limited to, prohibitions on the submission of binding shareholder proposals or ownership requirements in excess of those imposed by Rule 14a-8.  ISS will continue to issue negative voting recommendations each year that these restrictions remain in place.  Prior to this update, ISS did not have a stated position on this issue.

Unilateral Bylaw/Charter Amendments and Multi-Class Capital Structures at IPO Companies

ISS now will generally recommend votes “against” all directors other than new nominees if a company completes an IPO with a multi-class capital structure in which the classes do not have equal voting rights.  Prior to this update, ISS recommended votes “against” directors of IPO companies if the company had provisions in its charter or bylaws that were “materially adverse” to shareholder rights, and ISS provided a list of factors that could change the presumption of a negative voting recommendation, including a public commitment to put the adverse provision to a shareholder vote within three years of the date of the IPO.

Under the new guidance, if, prior to the IPO, the company or its board adopted charter or bylaw provisions materially adverse to shareholder rights, or implemented a multi-class capital structure in which the classes have unequal voting rights, ISS will recommend a vote “against” all directors except new nominees, unless there is a reasonable sunset provision (i.e., a commitment to hold a shareholder vote within three years will no longer be sufficient).  In addition to the sunset provision, as under its current policy, ISS will continue to consider a list of factors in making its final voting recommendation.  In addition, unless the adverse provision and/or problematic capital structure is reversed or removed, ISS will recommend votes case by case on director nominees in subsequent years.

Capital

Stock Distributions:  Splits and Dividends

ISS has a voting policy that specifically addresses common stock authorizations in connection with a stock split or stock dividend, and it has clarified this policy for 2017.  In connection with a planned stock split or stock dividend, a company may need to increase the number of authorized shares of its common stock, which would require shareholder approval.  The company may seek approval for a total number of shares that exceeds the number it anticipates distributing in connection with the stock split or stock dividend.  As updated, the ISS policy now makes clear that ISS will generally vote “for” these proposals as long as the “effective” increase in authorized shares satisfies ISS’s common stock authorization policy.  As we understand it, this clarification means that, in evaluating the impact of the increase on a company’s authorized share capital, ISS will continue to consider only the number of excess shares–that is, shares over and above those to be issued as a planned stock split or stock dividend.

Executive Compensation

Equity-Based Incentive Plans

ISS has changed aspects of its “Equity Plan Scorecard,” which is part of its proxy voting policy for equity-based incentive plans.   Specifically, ISS has added a factor to the Equity Plan Scorecard that considers whether dividends or dividend equivalents related to an equity award can be payable prior to vesting of the award.  Under the new factor, equity plans that explicitly prohibit the payment of all dividends or dividend equivalents before the vesting of the underlying equity award will receive full credit, while companies will receive no credit if the prohibition is “absent or incomplete” (that is, it does not apply to all types of awards).  A company’s general practice to withhold dividends during the vesting period is insufficient to receive credit under the Equity Plan Scorecard if the policy is not made explicit in the equity plan document.  A provision that allows the accrual of dividends/dividend equivalents payable upon vesting is sufficient as long as dividends are withheld during the vesting period.

In addition to adding the new factor, ISS has also changed the factor in the Equity Plan Scorecard related to minimum vesting periods.  Under the updated factor, in order to receive full credit, an equity plan must specify a minimum vesting period of at least one year that applies to all award types and that cannot be overridden in individual award agreements.  This is a change from the prior version of the factor, which only required that the minimum vesting period apply to one type of award and was silent with respect to individual award agreements.

Amendments to Cash and Equity Incentive Plans

ISS clarified how it will evaluate proposals to amend cash or equity incentive plans by more clearly differentiating the framework it will apply to various types of amendments.  ISS’s recommendation on amendments to all plans (whether cash, stock, or a combination of the two) that only seek shareholder approval of performance metrics for Section 162(m) purposes (other than in connection with the first such approval following an IPO) will depend on whether the board committee administering the plan consists entirely of independent directors.  Note that for these purposes ISS applies its definition of “independence”, not the applicable New York Stock Exchange or NASDAQ definition.  All other cash and equity plan amendments will receive recommendations on a case-by-case basis.  The amendments do not substantively change the ISS policy; they merely clarify its application.

Pay-for-Performance Updates

Separately, ISS also recently announced that it would incorporate an additional proprietary financial performance metric into the pay-for-performance analysis it uses in evaluating a company’s executive compensation and say-on-pay proposal.  When evaluating executive compensation, ISS currently applies a quantitative screen that uses three metrics: (a) the degree of alignment between the company’s annualized total shareholder return (TSR) and the CEO’s annualized total awarded compensation, each measured on a relative basis within a peer group and over a three-year period; (b) the degree of absolute alignment between the trend in CEO pay and the company’s TSR over the prior five fiscal years; and (c) the multiple of the CEO’s total awarded compensation relative to the peer group median CEO total compensation. This quantitative screen is intended to flag companies where a potentially significant misalignment of pay and performance may exist and therefore where further assessment is warranted in the form of a qualitative pay-for-performance analysis.

Based on feedback obtained through its 2016 policy survey, ISS has announced that it will incorporate an additional pay-for-performance metric into its analysis beginning in 2017.  Specifically, ISS has developed a new metric that compares the relative degree of alignment between the CEO’s annualized total awarded compensation and the company’s performance as calculated by ISS based on six financial metrics, with both compensation and financial performance being measured relative to an ISS-selected peer group over a three-year period.  The six financial performance metrics that will be used in this analysis are (a) return on invested capital, (b) return on assets, (c) return on equity, (d) revenue growth, (e) EBITDA growth, and (f) growth in cash flow from operations.  The weight that ISS places on each of these six metrics will vary by industry for purposes of producing the new numerical weighted financial performance metric.  Beginning in 2017, ISS’s voting recommendation reports will present this information in a new standardized table that sets forth the company’s three-year performance based on TSR and on these six financial metrics relative to the company’s ISS selected peer group, compares performance on these metrics with relative compensation levels (in each case, relative to the ISS selected peer group), and presents the overall weighted financial performance metric.  Companies that subscribe to ISS’s executive compensation services will be able to view online projections of their relative financial performance evaluation under these new measures.

For 2017, ISS stated that it may use the relative financial performance information in the qualitative aspect of its pay-for-performance analysis.  Thus, no changes are being made for 2017 to ISS’s quantitative pay-for-performance analysis, although ISS is leaving the door open for changes in 2018 and beyond.  As with any standardized measure, some companies may object that the new financial performance measures utilized by ISS do not accurately portray their performance, and may object to the manner in which ISS weights the various financial performance measures.  The extent of these objections, and the extent to which shareholders embrace the ISS presentations, may well depend on the extent of transparency that ISS provides into its proprietary financial performance calculations and to the weight it assigns to each.

Director Compensation

Shareholder Ratification of Director Compensation Programs

ISS has added a new policy for evaluating company proposals seeking ratification of non-employee director compensation.  ISS will vote case by case on these proposals, based on a list of factors.  The list of factors includes director compensation at comparable companies, the presence of “problematic” pay practices relating to director compensation, director stock ownership guidelines and holding requirements, equity award vesting schedules, the mix of cash and equity-based compensation, “meaningful” limits on director compensation, the availability of retirement benefits, and the quality of disclosure surrounding director compensation.  ISS will also consider whether or not the equity plan under which non-employee director grants are made warrants support, if that plan is up for shareholder approval.  This policy is being implemented in reaction to shareholder litigation over director compensation and the ensuing shareholder ratification proposals put forth by companies.

Equity Plans for Non-Employee Directors

ISS modified the factors considered when it evaluates equity compensation plans that apply solely to non-employee directors.  ISS will continue to evaluate plans on a case by case basis based on the estimated cost of the plan relative to peer companies, the company’s three-year burn rate relative to peer companies, and plan features.  In cases where director stock plans exceed ISS plan cost or burn rate benchmarks, in making its recommendation, ISS will continue to consider various factors relating to director compensation in formulating its voting recommendation.  However, rather than requiring that a company’s director compensation program meet certain enumerated criteria, which is the approach under ISS’s current policy, ISS will “look holistically” at all of the factors.  In addition, ISS has updated and expanded these factors so they are the same factors used in ISS’s new policy for evaluating company proposals seeking shareholder ratification of director compensation programs.

Glass Lewis 2017 Proxy Voting Policy Updates

On November 18, 2016, Glass Lewis released their updated proxy voting policy guidelines for 2017 in the United States and for shareholder proposals.  These guidelines are a detailed overview of the key policies Glass Lewis applies when making voting recommendations on proposals at U.S. companies and on shareholder proposals.  The four key changes in these 2017 guidelines are summarized below.

Overboarded Directors

As previously announced, beginning in 2017 Glass Lewis will generally recommend voting “against” a director who serves as an executive officer of any public company while serving on a total of more than two (instead of three) public company boards (including their own) and any other director who serves on a total of more than five public company boards.  However, Glass Lewis has introduced some flexibility in how it will apply this standard:

  • When determining whether a director’s service on an excessive number of boards may limit the director’s ability to devote sufficient time to board duties, Glass Lewis may consider relevant factors such as the size and location of the other companies where the director serves on the board, the director’s board duties at the companies in question, whether the director serves on the boards of any large privately held companies, the director’s tenure on the boards in question, and the director’s attendance record at all companies.
  • Glass Lewis may also refrain from recommending voting “against” certain directors if the company provides sufficient rationale in the proxy statement for their continued board service.  Glass Lewis believes that this rationale “should allow shareholders to evaluate the scope of the directors’ other commitments as well as their contributions to the board including specialized knowledge of the company’s industry, strategy or key markets, the diversity of skills, perspective and background they provide, and other relevant factors.”
  • If directors are overboarded, Glass Lewis will not recommend that shareholders vote “against” overcommitted directors at the companies where they serve as an executive.

Board Evaluation and Refreshment

Glass Lewis clarified its approach to board evaluation, succession planning and refreshment.  Generally speaking, Glass Lewis believes a robust board evaluation process–one focused on the assessment and alignment of director skills with company strategy–is more effective than solely relying on age or tenure limits.  This discussion appears in a newly captioned section entitled “Board Evaluation and Refreshment” in the U.S. Guidelines and reflects a shift in focus from a similar discussion that previously appeared under the heading “Mandatory Director Term and Age Limits.”

Governance Following an IPO or Spin-Off

Glass Lewis clarified how it approaches corporate governance at newly public entities. While it generally believes that such companies should be allowed adequate time to fully comply with marketplace listing requirements and meet basic governance standards, Glass Lewis will also review the terms of the company’s governing documents in order to determine whether shareholder rights are being severely restricted from the outset.  If Glass Lewis believes the board has approved governing documents that significantly restrict the ability of shareholders to effect change, it will consider recommending that shareholders vote “against” members of the governance committee or the directors that served at the time of the governing documents’ adoption, depending on the severity of the concern.  The new guidelines outline the specific areas of governance Glass Lewis will review (for example, antitakeover provisions, supermajority vote requirements, and general shareholder rights, such as the ability of shareholders to remove directors and call special meetings).

Gender Pay Equity Shareholder Proposals

Glass Lewis codified its policy concerning shareholder proposals requesting that companies provide increased disclosure concerning efforts taken to ensure gender pay equity.  Glass Lewis will review these proposals on a case by case basis and will consider (a) the company’s industry; (b) the company’s current policies, efforts and disclosure with regard to gender pay equity; (c) the practices and disclosure of company peers; and (d) any relevant legal and regulatory actions at the company. Glass Lewis will consider recommending votes in favor of “well-crafted shareholder resolutions requesting more disclosure on the issue of gender pay equity in instances where the company has not adequately addressed the issue and there is credible evidence that such inattention presents a risk to the company’s operations and/or shareholders.”

Actions Public Companies Should Take Now

  • Evaluate your company’s practices in light of the revised ISS and Glass Lewis proxy voting guidelines:  Companies should consider whether their policies and practices, or proposals expected to be submitted to a shareholder vote in 2017, are impacted by any of the changes to the ISS and Glass Lewis proxy voting policies.  For example, companies should consider whether any directors or director nominees would be considered “overboarded” under the updated policies.
  • Update ISS on your compensation peer group:  ISS is inviting companies to notify it of changes companies have made to the peer companies they use for determining compensation where the company’s next annual meeting will be held between February 1, 2017, and September 15, 2017.  ISS factors the company-selected peer companies into its peer group construction process as part of its compensation-related voting recommendations.  Companies do not need to submit an update if the peer group has not changed since the last proxy statement.  ISS will automatically use the peers disclosed in a company’s last proxy statement if no updates are submitted.  The ISS peer submission window will be open for these U.S. companies from 9:00 AM EST on Monday, November 28, 2016 until 8:00 PM EST on Friday, December 9, 2016.   Companies can submit the updates by logging onto the ISS Corporate Solutions website at https://login.isscorporatesolutions.com.
  • Check your ISS QualityScore Scores:  In late October, ISS announced QualityScore, a rebranded and revised version of its corporate governance ratings system.  Following a data verification period, ISS released on November 21, 2016, the new QualityScore ratings for companies.  These scores will be publicly available on Yahoo! Finance and included in the ISS reports containing proxy voting recommendations for shareholder meetings.  However, a company cannot update its QualityScore data once it files the proxy statement.  Thus, companies are encouraged to review in advance the new QualityScore scores and confirm the accuracy of the raw data that ISS is using.  QualityScore information can be accessed on the ISS Corporate Solutions website at https://login.isscorporatesolutions.com.
  • Enroll in the Glass Lewis 2017 Issuer Data Report (IDR) program: Glass Lewis has opened enrollment for its 2017 Issuer Data Report (IDR) program.  The IDR program enables public companies to access (for free!) a data-only version of the Glass Lewis Proxy Paper report prior to Glass Lewis completing its analysis and recommendations relating to public company annual meetings.  Glass Lewis does not provide drafts of its voting recommendations report to issuers it reviews, so the IDR is the only way for companies to confirm the accuracy of the data before Glass Lewis’s voting recommendations are distributed to its clients.  Moreover, unlike ISS, Glass Lewis does not provide each company with complimentary access to the final voting recommendations for the company’s annual meeting.  IDRs feature key data points used in Glass Lewis’s corporate governance analysis, such as information on directors, auditors and their fees, summary compensation data and equity plans, among others.  The IDR is not a preview of the final Glass Lewis analysis as no voting recommendations are included.  Each participating public company receives its IDR approximately three weeks prior to its annual meeting and generally has 48 hours to review the IDR for accuracy and provide corrections, including supporting public documents, to Glass Lewis.  Participation is limited to a specified number of companies, and enrollment is on a first-come, first-served basis.  Enrollment closes on January 6, 2017, or as soon as the annual limit is reached.  To learn more about the IDR program and sign up to receive a copy of the 2017 IDR for your company, go to https://www.meetyl.com/issuer_data_report.

This post comes to us from Gibson, Dunn & Crutcher LLP. It is based on the firm’s memorandum, “Proxy Advisory Firm Updates and Action Items for 2017 Annual Meetings,” dated November 22, 2016, and available here.