Proxy advisory firms Institutional Shareholder Service ("ISS") and Glass Lewis & Co. ("Glass Lewis") recently released their United States policy recommendations for the 2016 proxy season.
ISS updated its policy recommendations to:
- Tighten restrictions on overboarded directors by decreasing the number of boards on which directors may serve;
- Discourage unilateral bylaw/charter amendments by continuing vote withholding for persistent problems;
- Clarified its policy regarding director elections in proxy contests and proxy access efforts by expanding the analytical framework used to evaluate nominees in contested elections;
- Addressed perceived compensation issues, by encouraging:
- greater executive compensation disclosure by externally managed issuers;
- enhanced disclosure of hold-equity-past-retirement requirements; and
- Enhance disclosure of environmental and social issues, including animal welfare, pharmaceutical pricing, and climate change.
Glass Lewis updated its policy recommendations to:
- Tighten restrictions on overboarded directors by decreasing the number of boards on which directors may serve;
- Clarify its policies on conflicting management and shareholder proposals;
- Loosen negative consideration of exclusive forum provisions if they are adopted pre-IPO or in connection with an IPO;
- Link nominating committee performance to company performance;
- Enhance compensation disclosure of one-time and transitional payments; and
- Encourage environmental and social risk mitigation through board oversight.
ISS 2016 proxy guideline updates
Tightens restrictions on overboarded directors
ISS reduced the number of public company boards on which a director is allowed to serve from six to five. Under the revised policy, serving on more than five public company boards will cause a withhold vote recommendation from ISS. CEOs may sit on two public company boards other than the CEO's own company board. While the CEO board service does not represent a change from prior years, ISS indicated that they are willing to consider a reduction here as well. The reduction from six to five, will apply for meetings on or after Feb. 1, 2017.
ISS's rational for the change is that, according to ISS, recent academic research shows a negative correlation between directors' "busyness" and positive company performance. Average time commitment for board service has expanded such that directors now spend an average of 35 eight-hour work days a year in service on a single board (including ancillary meetings with management). This is up sharply from an average of just under 24 eight-hour work days in 2005. Some boards have addressed over-commitment by limiting overboarded directors through the operations of their nominating committees or by imposing direct limits on board members, usually limiting board member's service to four companies.
Discourages unilateral bylaw/charter amendments
ISS already discourages unilateral charter and bylaw amendments by the board that could negatively affect shareholder rights or protections. For 2016, ISS has refined its methodology in two ways:
- ISS has separated the analysis of bylaw and charter amendments that occur pre-IPO from amendments that occur after the IPO, giving a somewhat less negative view to the former and discouraging the latter; and
- ISS states that it will remember these unilateral actions when considering board nominees year after year until the actions are reversed or are submitted to a binding vote of public shareholders.
ISS specifically recommends voting against or withholding votes from directors individually, committee members, or the entire board (except new nominees, who should be considered in a case-by-case basis) if the board amends the company's bylaws or charter in a way that adversely impacts shareholders' rights. These include amendments to:
- classify the board;
- adopt supermajority vote requirements to amend the bylaws or charter; or
- eliminate shareholders' ability to amend bylaws.
Shareholders of established companies and newly public companies are encouraged by ISS to consider a laundry list of criteria to determine if shareholders' rights have been adversely impacted. The list of criteria to consider differs slightly for established and newly public entities.
ISS's rational for these changes is to clarify that institutional investors expect different governance structures from newly public companies than from established public companies, but in both cases ISS discourages changes they view as adverse to shareholders. For example, over two-thirds of "emerging growth companies" with post-2013 IPOs implemented pre-IPO changes to reduce director accountability and implement supermajority requirements to amend governing documents. A perceived increase in existing public company boards circumventing shareholder votes through unilateral amendments to company bylaws encouraged ISS to make these changes. In 2013, there were 10 cases of these "adverse" unilateral amendments, while in 2014 this jumped to 64, and 62 so far in 2015. Institutional investors also requested that ISS continue the no-vote or withholding recommendation until the unilateral amendment is reversed or "cleansed" by a binding shareholder approval.
Clarifies voting for director nominees in contested elections during proxy access/contests
In light of the recent rise in shareholder proposals seeking proxy access rights over the past couple years (18 proposals, with five receiving majority support, in 2014; 90 proposals, with 52 receiving majority support, in 2015), ISS has made a slight clarification to its analytical framework regarding proxy contests and proxy access. Previously, ISS had one framework for evaluating contested director nominations that covered both nominees put forward as part of proxy contests and nominees related to proxy access proposals. However, ISS recognized that the circumstances motivating proxy contests may differ significantly from those animating proxy access proposals. While ISS retained the existing list of factors to be considered in the contested election, it added the following clarifying language:
"In the case of candidates nominated pursuant to proxy access, vote case-by-case considering any applicable factors listed above or additional factors which may be relevant, including those that are specific to the company, to the nominee(s) and/or to the nature of the election (such as whether or not there are more candidates than board seats)."
ISS views this additional language as a means to encourage shareholders to consider the varied reasons why a proposed nominee may have been put forward – a nomination may stem from a general disagreement with the existing board over strategy, but it could also be limited to addressing a discreet issue such as "board diversity or boardroom skills."
Clarifies compensation issues
Expanded executive compensation disclosure by Externally Managed Issuers
ISS updated its Problematic Pay Practice policy by adding "Insufficient Executive Compensation Disclosure by Externally Managed Issuers (EMIs)" to its lists of practices that may result in an adverse recommendation on the advisory vote on executive compensation. ISS stated that many EMIs fail to provide enough information to enable shareholders to evaluate compensation arrangements with an EMI's named executives, and that this lack of disclosure made EMIs' say-on-pay votes ineffectual.
ISS stated that some companies already provide enhanced disclosure about the value and nature of EMI's compensations arrangements within the constraints of company agreements with external management. This recommendation is intended to broaden this practice enough to allow shareholders to make a reasonable assessment of the EMI's pay program and practices.
Encourages holding equity past retirement or for a significant period of time
ISS streamlined and simplified its recommendations regarding proposals requiring a company to adopt policies that require executives hold equity until or past termination of employment. Specifically, ISS broadened its policy to encompass shareholder proposals that ask companies to adopt executive equity retention policies. The new more general approach eliminates the need for a separate ISS policy covering shareholder proposals seeking retention of 75% of net shares. It also clarified that the shareholder's proposed retention ratio and the required duration of retention are some of the factors that will be considered in the case-by-case analysis.
The restated ISS policy recommends shareholders vote case-by-case on shareholder proposals that request senior executive officers retain a portion of net shares acquired through compensation plans. ISS states that shareholders should consider the following factors when deciding how to vote:
- The percentage/ratio of net shares retained;
- The time period required to retain the shares;
- Whether the company has equity retention, holding period, and/or stock ownership requirements in place and the robustness of such requirements;
- Whether the company has any other policies aimed at mitigating risk taking by executives;
- Executives' actual stock ownership and the degree to which it meets or exceeds the proponents' suggested holdings period/retention ratio or the company's existing requirements; and
- Problematic pay practices, current and past, which may demonstrate a short-term versus long-term focus.
Expands environmental and social issue disclosure
ISS has revised several of its environmental and social policy recommendations, including:
- Animal welfare: ISS revised its recommendation to vote for proposals seeking a report on animal welfare standards by (1) expanding the scope of proposals covered to include "animal welfare-related risks", (2) requesting disclosure of "controversies", in addition to fines and litigation, related to the company's and/or its suppliers' treatment of animals, and (3) requesting disclosure related to supply chain risks through disclosure of suppliers' animal welfare related fines, litigation, and controversies.
- Pharmaceuticals: ISS expended the topics considered when facing a shareholder proposal that requests a report on a company's product pricing and access to medicine polices by (1) adding regulatory risk to the description of reputational and market risk exposure, and (2) adding desired disclosure of policies related to "recent significant controversies, litigation, or fines at the company." These updates codify ISS's current practice. The addition is meant to reflect the increased criticism regarding the pricing of pharmaceutical products, especially in regards to specialty drugs.
- Climate change/emissions: ISS slightly changed its recommendation on proposals requesting companies disclose information on the impact of climate change on its operations and investments by adding clarifying language that this disclosure should cover "financial, physical, or regulatory risks." This is a result of the rise of shareholder proposals during the 2015 proxy season addressing fossil fuel and carbon asset risks and strategies for reductions in oil and gas usage due to global climate change.
Glass Lewis 2016 proxy guidelines
Tightens director overboarding policy
Glass Lewis recognized that the time directors devote to board obligations has increased in recent years. For 2017, Glass Lewis will begin to recommend voting against non-executive directors serving on more than five public-company boards and executive directors serving on more than a total of two public-company boards. However, for 2016, Glass Lewis notes that director overboarding on the levels set out above will be identified as a concern, but Glass Lewis will only recommend a vote against a director if the non-executive director serves on six public company boards or if an executive director serves on more than three public company boards.
Clarifies analysis of conflicting management and shareholder proposals
On October 22, 2015, the SEC released Staff Legal Bulletin No. 14H ("SLB 14H") which clarified its rule concerning the exclusion of certain shareholder proposals when similar items are on the ballot. SLB 14H makes it harder for companies to prove a conflict exists between management and shareholder proposals. For the 2016 proxy season, Glass Lewis recommends shareholders consider the following factors when determining whether to support management proposals or conflicting shareholder proposals:
- the nature of the underlying issue;
- the benefits to shareholders from implementation of the proposal;
- the materiality of the differences between the terms of the shareholder proposal and management proposal;
- the appropriateness of the provisions in the context of the company's shareholder base, corporate structure and other relevant circumstances; and
- a company's overall governance profile and, specifically, its responsiveness to shareholders as evidence by the company's response to previous shareholder's proposals and its adoption of progressive shareholder rights provision.
Loosen exclusive forum provisions discouragement for pre-IPO companies
Glass Lewis will no longer recommend shareholders vote against the chairman of the nominating and governance committee of newly-public companies that include an exclusive forum provision in their governing documents. Instead, Glass Lewis recommends shareholders weigh the presence of an exclusive forum provision in a newly-public company bylaws in conjunction with other provisions that it views as inappropriately limiting shareholder rights, such as supermajority vote requirements, classified boards, and fee-shifting bylaws. The recommendation against chairmen of nominating and governance committees that adopt exclusive forum provisions outside the context of a spin-off, merger, or IPO, without shareholder approval, remains unchanged.
Linking nominating committee performance to company performance
The revised guidelines clarify that Glass Lewis may recommend shareholders vote against the chair of the nominating committee where the board of directors' has failed to ensure that the directors have relevant experience, either through periodic director assessment or board refreshment, and that failure has contributed to a company's poor performance.
Clarifies one-time and transitional compensation policy
In light of Glass Lewis' generally wariness of awards granted outside a company's standard incentive scheme, Glass Lewis has identified specific factors regarding one-time and transitional awards that it evaluates when considering these awards and disclosure about them. While Glass Lewis recognized that one-time payments may be appropriate, shareholders need to be provided with meaningful explanations of these awards. Glass Lewis recommends companies:
- provide a description of the awards, including cogent and convincing explanation of their necessity and why existing awards do not provide sufficient motivation;
- tie one-time and transitional awards to future service, if possible;
- clearly disclose sign-on bonuses and provide meaningful explanation of the payments and the process by which the amounts are reached; and
- provide details of and the basis for any "make-whole" payments.
When assessing the appropriateness of sign-on and severance arrangements, Glass Lewis recommends shareholders consider the executive's regular target compensation or the sums paid to other executives (including the recipient's predecessor). When evaluating supplemental awards, Glass Lewis continues to recommend shareholders evaluate the terms and size of the grants in the context of the company's overall incentive strategy and granting practices, as well as the current operating environment. Companies should continue to disclose how supplemental or one-time payments will affect regular compensation arrangements.
Expands environmental and social risk oversight
Glass Lewis codified its policy regarding the responsibilities of directors for oversight of environmental and social issues and provided some added clarity about situations in which Glass Lewis would recommend a vote against a director due to lapses in environmental or social risk management. These policies are based on Glass Lewis' position that identification, mitigation, and management of environmental and social risks are integral components of a company's overall risk exposure. Specifically Glass Lewis recommends that boards: (1) ensure management performs a complete risk analysis, and (2) monitors management's mitigation of environmental and social risks. Glass Lewis will recommend voting against directors responsible for risk oversight when the board or management has failed to manage environmental or social risk at the expense of shareholder value.