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.

Background

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.”

Data Verification

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 Updates

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.”

Practical Considerations

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.

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_{1. You can access the ISS QuickScore website by clicking here. Click here to download the QuickScore 3.0 Overview and Updates document and the QuickScore 3.0 Factors by Region Appendix, each of which will require you to provide registration information.}

_{2. To access the data verification site, users will need log-in information, unless they already have an ISS log-in. The QuickScore 3.0 website has information on how to obtain log-in information and where to direct questions regarding the data verification process. Users should also reference ISS’ How to Verify Your Company’s Governance QuickScore Data by clicking here.}

_{3. See ISS, How to Verify Your Company’s Governance QuickScore Data, available at http://www.isscorporatesolutions.com/sites/default/files/images/QuickScore_DV_HelpGuide.pdf.}

_{EXHIBIT A}

_{Complete List of U.S. Factors}

_{The following is the list of QuickScore 3.0 factors for U.S. companies. The numbers next to each factor are part of ISS’ factor numbering system.}

_{New factors are in bold and factors with an asterisk (*) are “zero-weight” factors that do not count towards a company’s score and are merely for informational purposes.}

_{Audit & Risk Oversight}

_{1 Non-Audit fees represent what percentage of total fees?}

_{2 Did the auditor issue an adverse opinion in the past year?}

_{3 Has the company restated financials for any period within the past two years?}

_{4 Has the company made non-timely financial disclosure filings in the past two years?}

_{5 Has a regulator initiated enforcement action against the company in the past two years?}

_{200 Has a regulator initiated enforcement action against a director or officer of the company in the past two years?}

_{201 Is the company, a director or officer of the company currently under investigation by a regulatory body?}

_{8 Has the company disclosed any material weaknesses in its internal controls in the past two fiscal years?}

_{6 How many financial experts serve on the audit committee?} 

_{Board Structure}

_{9 How many directors serve on the board?*}

_{304 What is the number/proportion of women on the board?}

_{10 What is the independent director composition of the Board?}

_{13 What proportion of non-executive directors on the board has lengthy tenure?}

_{14 What is the classification of the Chairman of the Board?}

_{16 Has the company identified a Senior Independent Director or an independent Lead Director?}

_{205 What percentage of the board consists of immediate family members of majority shareholders, executives and former executives (within the past five years)?*}

_{206 What percentage of the board are former or current employees of the company?*}

_{19 What is the independent status of the nominating committee members?}

_{25 What is the independent status of the compensation committee members?}

_{31 What is the independent status of the audit committee members?}

_{37 Does the CEO serve on an excessive number of outside boards?}

_{38 How many non-executives serve on an excessive number of outside boards?}

_{45 Did any directors attend less than 75% of the aggregate board and applicable key committee meetings without a valid excuse?}

_{49 How many directors received withhold/against votes of 50% or greater at the last annual meeting?}

_{312 What percentage of directors received shareholder approval rates below 80%?}

_{315 What was the average outside director's total compensation as a multiple of the peer median?}

_{144 Do all directors with more than one year of service own stock?}

_{243 Did any executive or director pledge company shares?}

_{41 Does the company disclose a policy requiring an annual performance evaluation of the board?}

_{46 Does the company disclose board/governance guidelines?}

_{143 Are directors subject to stock ownership guidelines?}

_{244 Does the company have a robust policy prohibiting hedging of company shares by employees?}

_{50 What percent of the directors were involved in material related party transactions (RPTs)?}

_{51 Do the directors with RPTs sit on key board committees?}

_{216 Are there material related-party transactions involving the CEO?}

_{99 Has the board failed to implement a shareholder resolution supported by a majority vote, or failed to address the issue underlying majority director WHs?}

_{345 Has ISS' review found that the Board of Directors recently took action that materially reduces shareholder rights?}

_{Shareholder Rights & Takeover Defenses}

_{54 Does the company have classes of stock with different voting rights?}

_{55 Are there any directors on the board who are not up for election by all classes of common shareholders?}

_{56 Is there a sunset provision on the company's unequal voting structure?}

_{77 Are all directors elected annually?}

_{83 Is the board authorized to issue blank check preferred stock?}

_{78 Does the company have a poison pill (shareholder rights plan) in effect?}

_{79 What is the trigger threshold for the poison pill?}

_{80 Does the poison pill have a sunset provision?}

_{81 Does the poison pill have a three-year independent director evaluation provision?*}

_{82 Does the poison pill have a qualified offer clause?}

_{91 What is the expiration date of the poison pill?}

_{220 Is the poison pill designed to preserve tax assets (NOL pill)?}

_{222 When was the poison pill implemented or renewed?}

_{223 Does the company's poison pill include a modified slow-hand or dead-hand provision?}

_{290 Does the company have a controlling shareholder?*}

_{224 If the company has a majority voting standard, is there a plurality carve-out in the case of contested elections?}

_{89 Does the company require a super-majority vote to approve amendments to the charter and bylaws?}

_{90 Does the company require a super-majority vote to approve mergers/business combinations?}

_{97 What is the percentage of share capital needed to convene a special meeting?}

_{98 Can shareholders act by written consent?}

_{52 Does the company have a majority vote standard in uncontested elections?}

_{225 Are there material restrictions as to timing or topics to be discussed, or ownership levels required to call the meeting?}

_{Compensation/Remuneration}

_{226 What is the degree of alignment between the company's cumulative 3-year pay percentile rank, relative to peers, and its 3-year cumulative total shareholder return (TSR) rank, relative to peers?*}

_{227 What is the degree of alignment between the company's 1-year pay percentile rank, relative to peers, and its 1-year TSR rank, relative to peers?*}

_{228 What is the size of the CEO's 1-year pay, as a multiple of the median pay for company peers?}

_{229 What is the degree of alignment between the company's TSR and change in CEO pay over the past five years?}

_{232 What is the ratio of the CEO's total compensation to the next highest paid executive?}

_{329 What is the degree of alignment between the company's annualized 3-year pay percentile rank, relative to peers, and its 3-year annualized TSR rank, relative to peers?}

_{156 Are any of the NEOs eligible for multi-year guaranteed bonuses?}

_{237 What is the ratio of the CEO's non-performance-based compensation (All Other Compensation) to Base Salary?}

_{129 Do the company's active equity plans prohibit share recycling for options/stock appreciation rights (SARs)?}

_{138 Do the company's active equity plans prohibit option/SAR repricing?}

_{238 Does the company's active equity plans prohibit option/SAR cash buyouts?}

_{239 Do the company's active equity plans have an evergreen provision?}

_{240 Do the company's active equity plans have a liberal change-in-control definition?}

_{139 Has the company repriced options or exchanged them for shares, options or cash without shareholder approval in the last three years?}

_{130 Does the company's average 3-year equity grant rate exceed the greater of 2 percent and the average of its industry/index peers?}

_{155 Did the company disclose a claw back or malus provision?}

_{131 What are the vesting periods mandated in the plan documents for executives' stock options or SARS in the equity plans adopted/amended in the last 3 years?}

_{132 What are the vesting periods mandated in the plan documents, adopted/amended in the last three years, for executives' restricted stock/stock awards?}

_{134 What is the holding/retention period for stock options (for executives)?}

_{135 What is the holding/retention period for restricted shares/stock awards (for executives)?}

_{145 What proportion of the salary is subject to stock ownership requirements/guidelines for the CEO?}

_{113 Does the company disclose a performance measure for the short-term incentive plan (for executives)?}

_{246 What is the level of disclosure on performance measures for the latest active or proposed long-term incentive plan?}

_{328 Did the most recent Say-on-Pay proposal receive shareholders' support below 70%?}

_{148 What's the trigger under the change-in-control agreements?}

_{153 Do equity-based plans or other long-term awards vest completely upon a change-in-control?}

_{161 What is the multiple of pay in the severance agreements for the CEO (upon a change-in-control)?}

_{247 What is the basis for the change-in-control or severance payment for the CEO?}

_{162 Does the company provide excise tax gross-ups for change-in-control payments?}

_{163 What is the length of employment agreement with the CEO?*}

_{300 Has ISS' qualitative review identified a pay-for-performance misalignment?}

_{301 Has ISS identified a problematic pay practice or policy that raise concerns?}