Cleary Gottlieb Discusses Updates to Proxy Adviser Guidelines

As 2018 draws to a close, both Institutional Shareholder Services Inc. (“ISS”) and Glass Lewis are in the process of updating their 2019 proxy voting guidelines.

In mid-October, ISS launched its 2019 benchmark voting policy consultation period, pursuant to which ISS solicits feedback on certain of its proposed voting policies for the upcoming proxy season.  This year, ISS requested comment on proposed policies for U.S. public companies related to board gender diversity and its pay-for-performance model, as described in greater detail below.  ISS plans to announce its final policy changes in mid-November.

In addition, Glass Lewis recently released its 2019 shareholder initiatives and proxy voting guidelines, which include the implementation of previously announced policies that were in grace periods, new policies and codifications and clarifications of previously existing approaches to issuing vote recommendations.[1]

A summary of notable executive compensation and governance updates is provided below.  The recent policy updates, and in particular the new Glass Lewis guidelines, are fairly extensive.  In preparing for the 2019 proxy season, U.S. public companies should consider the applicability of the new and proposed policies in light of their individual facts and circumstances.

ISS Proposed Policy Updates

  • Board Gender Diversity. In light of increased shareholder concerns about board gender diversity, ISS is requesting comment on a new voting policy under which ISS would recommend an against or withhold vote from the chair of the nominating committee (or other directors who are responsible for the board nomination process on a case-by-case basis)[2]at companies where there are no female directors on the board.  Mitigating factors that ISS may consider would include (i) a firm commitment, as stated in the proxy and/or other Securities and Exchange Commission (“SEC”) filings, to appoint at least one female director to the board in the near term (before the next annual meeting); (ii) the presence of at least one female director on the board at the immediately preceding annual meeting; and/or (iii) any other relevant compelling factors.  This proposed policy would apply to companies in the Russell 3000 and S&P 1500, and would be effective for meetings on or after February 1, 2020.  ISS is seeking comment on the circumstances under which it should consider recommending against directors other than the chair of the nominating committee, whether there are other mitigating factors ISS should consider that would temporarily excuse the absence of a female director on the board, the appropriate time commitment to appoint a female director to an all-male board and whether the one year transition period is sufficient to implement the proposed policy.[3]
  • Pay-for-Performance Model. Beginning in 2018, ISS introduced an additional modifier, the Financial Performance Assessment (“FPA”), as part of its pay-for-performance secondary screen in order to provide a broader picture of company performance based on unadjusted GAAP accounting data.  ISS is now proposing to update the FPA measure to use “Economic Value Added”[4]in lieu of unadjusted GAAP measures.  This modification is designed to improve comparability of companies across different industries and to create a more reliable and accurate view of company performance.  ISS is requesting comment as to whether total shareholder return should continue to be used as ISS’s primary performance metric and whether companies would prefer that ISS continue to display GAAP performance data for informational purposes if the proposed policy becomes effective.[5]

New Glass Lewis 2019 Proxy Voting Guidelines

Executive Compensation Updates

  • Excise Tax Gross-Ups. Glass Lewis will now consider new excise tax gross-ups related to Section 4999 of the Internal Revenue Code (i.e., golden parachute gross-ups) as an additional factor that may contribute to a negative say-on-pay recommendation.  Depending on the circumstances, the addition of new gross-ups may also lead to negative vote recommendations against the chair of a company’s compensation committee, or the entire committee, particularly in cases where a company had previously committed not to provide any such entitlements in the future.  Glass Lewis will review gross-ups on other excise taxes or executive benefits on a case-by-case basis.  Previously having only addressed tax gross-ups in the context of say on golden parachute votes, this new policy effectively brings Glass Lewis in line with ISS’s longstanding view that tax gross-ups are a “problematic pay practice”.
  • Contractual Payments and Arrangements. Glass Lewis has extended its policy regarding contractual payments and arrangements and clarified terms that may contribute to a negative say-on-pay recommendation.
    • Sign-On Arrangements.  Sign-on arrangements (including “make-whole” payments) should be clearly disclosed and accompanied by a meaningful explanation of the payments and the process by which the amounts were reached.  Sign-on arrangements that are excessive may drive a negative say-on-pay recommendation.
    • Guaranteed Payments.Employment arrangements that provide for a minimum payout level under a given incentive arrangement and multiyear (as opposed to short term) guaranteed bonuses may lead to negative say-on-pay vote recommendations.
    • Severance. Cash severance entitlements should be consistent with general U.S. market practice—meaning in no instance (including a change in control) should such benefits exceed three times annual salary and, in many instances, annual bonus or include long-term incentives.  In addition, shareholders should be provided with meaningful explanations of any additional or increased severance benefits that were agreed upon outside of the regular arrangements.
  • Executive Compensation Disclosure for Smaller Reporting Companies. In light of the SEC’s adoption of amendments to raise the thresholds in the definition of “smaller reporting company”, therefore expanding the number of companies eligible to comply with reduced disclosure requirements, Glass Lewis has modified its approach to analyzing compensation committee performance.  Glass Lewis will consider the impact of materially decreased CD&A disclosure when formulating say-on-pay recommendations and may consider recommending against members of a compensation committee in instances where a reduction in disclosure substantially impacts shareholders’ ability to make an informed assessment of the company’s executive pay practices.  Companies that are now­—but were not previously—eligible for reduced disclosure should consider this guidance in determining whether to streamline their disclosure moving forward.
  • Grants of Front-Loaded Awards. When evaluating front-loaded awards, Glass Lewis will consider the quantum (on an annualized basis), design and the company’s rationale for granting such awards.  Additionally, Glass Lewis expects that any front-loaded awards should include a firm commitment not to grant additional awards for a defined period.  If a company breaks this commitment without providing a convincing rationale, Glass Lewis may recommend against the company’s pay program.  As front-loaded awards are becoming more common, with the 10-year performance-based stock option award granted to Elon Musk by Tesla and the similar “copycat” award given to Axon Enterprise Inc. CEO Rick Smith earlier this year as extreme examples, companies should be mindful of the new policy and carefully consider the rationale for these awards and the feasibility of a firm commitment, absent extraordinary circumstances, to not grant additional future awards for a defined period.
  • Recoupment Provisions. Glass Lewis has clarified its policy regarding recoupment provisions (“clawbacks”) and is focusing on the specific terms of these policies, rather than merely analyzing whether the clawback satisfies minimum legal requirements.  Glass Lewis indicated that it is prudent for boards to adopt detailed bonus recoupment policies that go beyond the requirements of Sarbanes-Oxley in order to prevent executives from retaining performance-based awards that were not truly earned.  According to Glass Lewis, clawbacks should be triggered, at a minimum, in the event of a restatement of financials or similar revision of performance indicators upon which bonuses were based.  Furthermore, in its shareholder initiatives, Glass Lewis explained that in instances where companies have not adopted policies that provide sufficient protections for reputational and financial harm, it may consider supporting well-crafted resolutions seeking to expand a company’s recoupment policy. We note that proposed clawback rules under Dodd-Frank have not yet been finalized, and many companies were waiting for final rules to be announced before adopting a formal clawback policy.  The increased scrutiny from the proxy advisory firms, coupled with the passage of time and mounting pressure from shareholders, will make it more difficult for companies to continue to delay the adoption of a recoupment policy.
  • Director Compensation. Glass Lewis clarified its voting policy on director compensation plans, indicating that where an equity plan exclusively or primarily covers non-employee directors as participants, the plan should not provide for performance-based awards in any capacity.  Further, when non-employee director equity grants are covered by the same equity plan that applies to a company’s broader employee base, Glass Lewis clarified that it will use its proprietary model to guide its voting recommendations.  If such a plan broadly allows for performance-based awards to non-employee directors or explicitly provides for such grants, Glass Lewis may recommend against the overall plan on this basis, particularly if the company has granted performance-based awards to non-employee directors in the past. This policy clarification supports the general market trend—motivated by recent Delaware case law—of companies adopting separate equity plans for non-employee directors.
  • Other Clarifications. Glass Lewis has also clarified several other elements of its current executive compensation policy guidelines, including updated language on how peer group discussions contribute to vote recommendations, a revised description of its pay for performance model and an additional discussion on the consideration of discretion in incentive plans.  It has also explained the structure and disclosure ratings in its Proxy Papers.

Governance Updates

  • Board Gender Diversity. Glass Lewis’ board gender diversity policy that was announced in November 2017 will take effect for meetings held on or after January 1, 2019 (more than a full year before the proposed ISS policy would take effect).  Glass Lewis will generally recommend voting against the nominating committee chair of a board with no female members.  Glass Lewis may also consider other factors, including the size of the company, the industry in which the company operates and the governance profile of the company, in deciding whether to extend an against recommendation to other nominating committee members.  Glass Lewis intends to review a company’s disclosure of its board diversity considerations, and when boards have provided a sufficient rationale for the lack of any female board members, or for companies outside of the Russell 3000 index, Glass Lewis may refrain from recommending shareholders vote against directors.

Glass Lewis framed the additional guidance in light of California’s Senate Bill 826, signed into law by California Governor Jerry Brown in September 2018. The bill requires all companies headquartered in the state to have one woman on their board by the end of 2019.  In addition, by the end of 2021, companies must have at least two women on boards of five members and at least three women on boards with six or more directors.  Accordingly, during the 2019 proxy season, if a company headquartered in California does not have at least one woman on its board, Glass Lewis will generally recommend voting against the chair of the nominating committee unless the company has disclosed a clear plan for how they intend to address this issue prior to the end of 2019.

More broadly, in its shareholder initiatives, Glass Lewis stated that it will generally support shareholder proposals requesting that companies provide disclosure concerning the diversity of their workforce, as well as those asking for details concerning how companies are promoting diversity within their workforce.

  • Virtual-Only Shareholder Meetings. Glass Lewis’ virtual-only shareholder meeting policy that was announced in November 2017 will go into effect for meetings held after January 1, 2019.  Glass Lewis may recommend voting against governance committee members for companies opting to hold a virtual annual shareholder meeting if the company does not provide disclosure ensuring that shareholders will be given the same rights and opportunities to participate that they would have had at an in-person meeting. Since the idea of virtual meetings is appealing to wide numbers of shareholders, companies should seriously consider the examples of effective disclosure that Glass Lewis provided, including:
    • Addressing the ability of shareholders to ask questions during the meeting, including time guidelines for shareholder questions, rules around what types of questions are allowed and rules for how questions and comments will be recognized and disclosed to meeting participants;
    • Procedures, if any, for posting appropriate questions received during the meeting, and the company’s answers, on the investor page of their website as soon as practical after the meeting;
    • Addressing technical and logistical issues related to accessing the virtual meeting platform; and
    • Procedures for obtaining technical support to assist in the event of any difficulties accessing the virtual meeting.
  • Conflicting and Excluded Proposals. Glass Lewis has codified its policy regarding conflicting special meeting shareholder resolutions:[6]
    • When companies place both a management and shareholder proposal on the ballot requesting different thresholds for the right to call a special meeting, Glass Lewis will generally recommend voting for the lower threshold (typically the shareholder proposal).
    • In situations with conflicting management and shareholder special meeting proposals, Glass Lewis may consider recommending that shareholders vote in favor of the shareholder proposal and abstain from voting on the management proposal.
    • In instances where companies have excluded a special meeting shareholder proposal in favor of a management proposal ratifying an existing special meeting right, Glass Lewis will generally recommend against the ratification proposal and members of the nominating and governance committee.

In addition, Glass Lewis may, in limited circumstances, recommend against the members of the governance committee in instances where Glass Lewis believes that the exclusion of any shareholder proposal (even where such exclusion is permitted by the SEC) was detrimental to shareholders.  This creates an interesting dynamic between SEC guidance and the influence of proxy advisory firms, and companies considering whether to seek SEC no-action relief on a particular shareholder proposal should be prepared to explain to their boards that a proposal excluded by the SEC may still be taken into consideration by Glass Lewis when making board voting recommendations for governance committee members.

  • Environmental and Social Risk Oversight. Glass Lewis has codified its approach to reviewing board oversight of environmental and social issues, resulting in three new pieces of guidance, described below.  Notably, Glass Lewis is looking for appropriate management of, and response to, environmental and social risks, which will look different for each company.  In addition, Glass Lewis announced this fall that guidance on material environmental social and governance topics from the Sustainability Accounting Standards Board will be integrated into its Proxy Paper research reports and vote management application, and noted in its shareholder initiatives that it will place significant emphasis on the financial implications of a company adopting, or not adopting, any proposed shareholder resolution on environmental and social issues.  As of 2017, Proxy Paper research reports and the Glass Lewis vote management application also integrated ratings, data and analysis from Sustainalytics.  Companies should analyze their own circumstances and may not necessarily need to make changes to their existing practices if they determine such risks are immaterial to their business.
    • For large cap companies and in situations with material oversight issues, Glass Lewis will review the company’s overall governance practices to identify which directors or board-level committees have been charged with oversight of environmental and/or social issues, while also noting instances where this oversight role has not been clearly defined in governance documents.
    • When it is clear that companies have not properly managed or mitigated environmental or social risks, resulting in the loss of, or threats to, shareholder value, Glass Lewis may consider recommending against members of the board who are responsible for the oversight of such risks.
    • Glass Lewis may recommend that shareholders vote against members of the audit committee in situations where there is an absence of explicit board oversight of environmental and social issues.
  • Other Clarifications. Glass Lewis also issued certain other clarifying amendments relating to auditor ratification, director recommendations on the basis of company performance, director and officer indemnification, NOL protective amendments, OTC-listed companies and quorum requirements.

ENDNOTES

[1] The guidelines are available at http://www.glasslewis.com/wp-content/uploads/2018/10/2019_GUIDELINES_UnitedStates.pdf and the shareholder initiatives are available at http://www.glasslewis.com/wp-content/uploads/2018/10/2019_GUIDELINES_ShareholderInitiatives.pdf.

[2] Note, under ISS policies, if the board is classified and ISS would have recommended an against or withhold vote on a director not otherwise up for election, all of the directors up for election will receive such recommendation.

[3] The proposal is available at https://www.issgovernance.com/file/policy/2018/DirectorElections-BoardGenderDiversity-US.pdf

[4] ISS defines Economic Value Added as a company’s Net Operating Profit After Tax less a “capital charge” (the cost to the company of providing an acceptable return to all capital providers).

[5] The proposal is available at https://www.issgovernance.com/file/policy/2018/ISSPayforPerformanceModel-FinancialPerformanceAssessmentMethodology-USandCanada.pdf

[6] It should be noted that in its shareholder initiatives, Glass Lewis indicated that in instances where a company has adopted a special meeting right of 15% or below and has adopted reasonable proxy access provisions, Glass Lewis will generally recommend that shareholders vote against shareholder proposals asking companies to adopt their bylaws to provide shareholders with the right to action by written consent.

This post comes to us from Cleary, Gottlieb, Steen & Hamilton LLP. It is based on the firm’s memorandum, “Recent Updates to Proxy Advisory Firm Guidelines,” dated November 1, 2018, and available here.

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