/>iAs calendar year-end companies ramp up for year-end reporting and proxy season, Institutional Shareholder Services (ISS) and Glass Lewis & Co. (GL) have released updates to their proxy voting guidelines.
GL’s comprehensive shareholder initiatives and proxy voting guidelines will be effective for annual meetings after January 1, 2019. GL’s updates are relatively extensive, and overlap with ISS to a limited extent.
GL compensation updates focus on front-loaded grants, recoupment/clawback policies and scaled CD&A disclosure for newly eligible smaller reporting companies.
ISS updated its QualityScore methodology, which applies to S&P 500 and Russell 3000 companies. The QualityScore changes track ISS’s updates to its proxy voting guidelines, which (similar to GL) focus on board gender diversity, shareholder proposals, and environmental and social (E&S) risk oversight.
ISS released preliminary U.S. compensation policy FAQs, which confirm that its passing scores for its Equity Plan Scorecard (EPSC) remain unchanged. Notably, ISS will delay the implementation of its excessive non-employee director compensation policy until 2020, and will recommend voting against the nominating committee chair or other members if an S&P 500 or Russell 3000 company does not have any female directors by 2020.
Notable governance and executive compensation updates are summarized below. As the 2019 proxy season gears up, companies should consider the new and updated ISS and GL policies in light of their own facts and circumstances.
ISS Updates Its Governance QualityScore Methodology
Last week, ISS announced updates to its Governance QualityScore methodology, which screens companies in the four areas of board structure, shareholder rights and takeover defenses, compensation/remuneration, and audit and risk oversight. [1] The updates, which are currently effective and impact S&P 500 and Russell 3000 companies, relate to: (i) the inclusion of the percentage of vote support for the CEO and the board chair within the board structure—controversies category; (ii) the inclusion of a new board structure—diversity subcategory, which will examine (a) the number of women serving in leadership roles on the board, (b) the number of women who are named executive officers at the company, (c) the standard deviation of director age, (d) the standard deviation of director tenure (in years), and (e) the lowest percentage of vote support received by management-nominated directors; and (iii) review of the percentage of vote support for the say-on-pay vote. The creation of a new board structure—diversity subcategory within ISS’s QualityScore methodology emphasizes the increasing institutional investor scrutiny of board gender diversity and parallels ISS’s updates to its 2019 proxy voting guidelines, discussed below. Companies may review their QualityScore data through ISS’s data verification site and submit corrections and changes to ISS until the filing of their definitive proxy statements.
ISS Updates Its Proxy Voting Guidelines and Issues Preliminary U.S. Compensation Policy FAQs
In late November, ISS released benchmark policy updates and preliminary U.S. compensation policy FAQs for annual meetings occurring on or after February 1, 2019. [2] Key updates for public companies listed in the United States include:
Board Gender Diversity . ISS announced that S&P 1500 and Russell 3000 companies lacking a female board member may receive adverse voting recommendations against nominating committee chairs, and on a case-by-case basis against other directors responsible for the board nomination process. The new policy will take effect for meetings on or after February 1, 2020. ISS may excuse a lack of board gender diversity if a firm commitment to appoint at least one woman to the board in the near term is included in the proxy statement, a female director was present at the preceding annual meeting, or other relevant factors exist.
Board Attendance . ISS will generally recommend a vote against, or withholding votes from, directors who attend less than 75% of their aggregate board and committee meetings for the fiscal year, unless a reasonable justification is disclosed in the proxy statement or another SEC filing. ISS announced that in cases of “chronic poor attendance,” which means three or more consecutive years of poor attendance without reasonable justification, it will recommend withholding votes from the chair of the nominating committee. After four years, ISS will recommend withholding votes from the entire nominating committee, and after five years, from all director nominees. In cases where a long-term pattern of absenteeism, such as poor attendance the previous year and three out of four prior years, ISS may also follow this new policy approach, and when the director is not on the ballot, as may be the case for a classified board, ISS will recommend withholding votes from the governance committee.
Management Proposals to Ratify Existing Charter or Bylaw Provisions . ISS will generally recommend voting against management proposals to ratify existing charter or bylaw provisions, unless the provisions align with best practice. In response to the increased use of management-sponsored proposals to justify the exclusion of “conflicting” shareholder proposals from the ballot during the 2018 proxy season, ISS has also adopted a new policy to vote against individual directors, governance committee members, or the full board, in cases where boards ask shareholders to ratify existing charter or bylaw provisions when certain factors are present, which factors may relate to (i) the presence of a shareholder proposal addressing the same issue on the same ballot; (ii) the board’s rationale for seeking ratification; (iii) the level of impairment to shareholders’ rights caused by the existing provisions; (iv) whether the current provision was adopted in response to the shareholder proposal; and (v) previous use of management proposals to exclude shareholder proposals.
Board Responsiveness . ISS has updated its existing board responsiveness policy to vote on a case-by-case basis on individual directors, committee members, or the entire board in circumstances where the board fails to act in response to a failed management proposal seeking ratification of an existing charter/bylaw provision.
Director Performance Evaluations . ISS updated its director performance evaluation policy to consider a company’s five-year total shareholder return (TSR) in the bottom half of a company’s four-digit GICS industry group as part of its initial director performance evaluation screening, instead of evaluating five-year TSR along with operational metrics during the secondary step of the evaluation. ISS believes that this change will reduce the number of companies that fail the initial screening.
Reverse Stock Splits . To address companies that are not listed on major stock markets or exchanges, ISS updated its reverse stock split policy to account for companies that are not required to proportionately reduce their authorized shares. In addition, ISS has broadened the policy to include other critical factors that may impact a company, such as disclosure of substantial doubt about the company’s ability to continue as a going concern, and the company’s rationale for a reverse stock split.
E&S Shareholder Proposals . ISS updated its E&S shareholder proposal policy to explicitly consider whether there are significant controversies, fines, penalties or litigation associated with the company’s E&S practices. ISS will continue to consider E&S proposals on a case-by-case basis, examining primarily whether implementation of the proposal is likely to enhance or protect shareholder value.
Pay-for-Performance . Commencing with the 2019 proxy season, ISS will phase in “Economic Value Added” (EVA) metrics to round out the market performance (TSR) and accounting performance (GAAP) measures utilized in ISS’s financial performance analysis. EVA data will not impact ISS’s quantitative pay-for-performance analysis at this time, although ISS will continue to consider using it.
Excessive Non-Employee Director Compensation . ISS intends to revisit its methodology for identifying excessive non-employee director (NED) pay. While ISS’s NED pay policy was scheduled to go into effect for the 2019 proxy season, ISS will endeavor to increase transparency around its NED pay outlier methodology and will not issue adverse director recommendations on this basis until 2020. Additional details will be forthcoming in late December 2018.
New EPSC “Negative Override” Factor . ISS announced a new negative override factor for excessive shareholder dilution under the S&P 500 and Russell 3000 EPSC models only. The new override will be triggered when a company’s equity plan is estimated to dilute shareholders by more than 20% (for the S&P 500 only) or 25% (for the Russell 3000 only). The override factor measures share capital dilution rather than voting power dilution, and is calculated as (A + B + C) ÷ CSO, where A = # new shares requested, B = # shares that remain available for issuance, C = # shares underlying unexercised/unvested outstanding awards, and CSO = common shares outstanding.
No Changes to EPSC Passing Scores . Passing scores for all U.S. EPSC models have not changed from the 2018 proxy season (which remain 55 points for S&P 500 companies, and 53 points for all others), although companies should expect that, consistent with past practice, ISS will reallocate the points and weightings among some of the individual factors within each EPSC model.
Updates to CIC Vesting Factor . ISS will assess the change in control (CIC) vesting factor for EPSC models to award points based on the quality of disclosure of CIC vesting provisions, rather than based on the actual vesting treatment of awards. Full points will be earned where the equity plan discloses with specificity the CIC vesting treatment for both performance- and time-based awards. If the plan is silent on the CIC vesting treatment or provides for discretionary vesting for either type of award, then no points will be earned.
ISS will publish its comprehensive proxy voting guidelines and complete FAQs by December 31, 2018. We will continue to monitor ISS for proxy and compensation guidance.
Glass Lewis Updates Its Proxy Voting Guidelines
GL recently published its 2019 Proxy Paper Guidelines. [3] Many of these changes will take effect for meetings held after January 1, 2019. GL also published its updated 2019 Proxy Paper Guidelines for Shareholder Initiatives, which reflect GL’s newly released policies relating to excluded shareholder proposals, diversity reports, and E&S proposals.
Board Gender Diversity. For Russell 3000 companies with meetings held after January 1, 2019, GL will generally recommend against a company’s nominating committee chair (and possibly other nominating committee members depending on other factors such as company size, industry, the state in which the company is headquartered [4] , and governance profile) if the company’s board has no female members, absent a sufficient rationale such as a disclosed timetable for addressing the lack of diversity on the board, or any notable restrictions regarding the board’s composition (e.g., director nomination agreements with investors).
Diversity Reporting Shareholder Proposals . GL will generally recommend in favor of shareholder proposals requesting enhanced disclosure of, and actions taken to promote, workforce diversity. Among other factors that GL will consider are (i) the company’s industry and nature of its operations, (ii) the company’s current level of workplace diversity disclosure, (iii) the level of disclosure by the company’s peers, and (iv) any lawsuits or accusations of discrimination at the company.
Conflicting and Excluded Shareholder Proposals . GL generally favors a 10-15% threshold for shareholder special meeting rights and will generally recommend voting for management or shareholder proposals that fall within this range. For ballots with conflicting management and shareholder proposals with different thresholds to call a special meeting, GL will generally recommend voting for the lower threshold and against the higher threshold. For ballots with conflicting management and shareholder special meeting proposals when the company does not currently offer a special meeting right, GL may consider recommending voting for the shareholder proposal and abstaining from management’s proposal. Where companies have excluded a special meeting shareholder proposal in favor of a management proposal ratifying an existing special meeting right, GL will generally recommend against management’s proposal, as well as against members of the nominating and governance committee. Finally, if GL determines that exclusion of a shareholder proposal based on SEC no-action relief was detrimental to shareholders, in very limited circumstances, GL may recommend against members of the governance committee.
Environmental and Social Risk Oversight . For large cap companies, and where GL identifies material E&S oversight issues, GL will review a company’s overall governance practices and identify which directors or committees have been charged with oversight of E&S issues. GL will also note instances where E&S oversight has not been clearly set out in a company’s governance documents. Where, to the detriment of shareholder value, companies have not properly managed or mitigated E&S risks, or where shareholder value is threatened by mismanagement, GL may consider recommending against directors responsible for E&S oversight, and if the board and/or a committee is not explicitly tasked with oversight, GL may recommend against audit committee members.
E&S Shareholder Proposals . GL will consider the financial implications of a company adopting an E&S shareholder proposal, taking into account standards developed by the Sustainability Accounting Standards Board with respect to financial materiality.
Auditor Ratification . GL will now consider auditor tenure, pattern of inaccurate audits, and any ongoing litigation or significant controversies which call into question auditor effectiveness and help assess whether shareholders would benefit from rotating auditors. In limited cases, these additional factors may contribute to a recommendation against auditor ratification.
Virtual Stockholder Meetings . For meetings held after January 1, 2019, GL will generally recommend a vote against governance committee members of a company that holds virtual-only shareholder meetings absent robust proxy statement disclosure assuring shareholders that they will be afforded participation rights similar to those they would have at an in-person meeting.
Written Consent Shareholder Proposals . GL has revised its policy to generally recommend against shareholder proposals requesting a shareholder right to action by written consent where companies have adopted a 15% or lower threshold for shareholder special meeting rights and reasonable proxy access provisions.
New Excise Tax Gross-Ups . The inclusion of new excise tax gross-ups in executive employment agreements may result in negative recommendations for a company’s say-on-pay vote, the chair of the compensation committee, or the entire committee, particularly in situations where a company previously committed not to provide such gross-ups in the future. GL will review gross-ups on other excise taxes or executive benefits on a case-by-case basis.
Contractual Payments and Arrangements . GL will consider general U.S. market practice, as well as the size and design of payments, when evaluating sign-on and severance arrangements. GL may make a negative recommendation on a say-on-pay vote if any of the following practices are present: (i) excessive sign-on awards; (ii) guaranteed incentive payouts, particularly over a multi-year period; and (iii) severance that exceeds the upper limit of general market practice, which GL has observed to be a multiple of three times (3x) salary and short-term bonus.
Scaled Compensation Disclosure for Smaller Reporting Companies . GL will consider the impact of materially decreased proxy disclosure and may recommend against compensation committee members where a reduction in disclosure substantially impacts shareholders’ ability to make an informed assessment of the company’s executive pay practices.
Grant of Front-Loaded Awards . GL will pay particular scrutiny to front-loaded awards, which GL views as less responsive than annual grants. Front-loaded awards will be evaluated taking into account the quantum (on an annualized, rather than lump sum, basis) and design of such grants, the company’s rationale for such grants, and company prior practice and peer data, among other benchmarks. GL expects any front-loaded awards to include a firm commitment not to grant additional awards for a defined period, but notes that unexpected circumstances may necessitate deviations to any firm commitments. As a result, GL may recommend against a say-on-pay vote if a company’s rationale for breaking the commitment is lacking.
Recoupment/Clawback Provisions . Recoupment or clawback provisions that satisfy the minimum legal requirements will be scrutinized and may inform GL’s overall view of a company’s compensation program. GL believes boards should adopt detailed recoupment policies to prevent executives from retaining performance-based awards that were not truly earned, with clawbacks being triggered in the event of a restatement of financial results or similar revision of performance metrics on which bonuses were based.
Short-Term Incentive Plans with Discretionary Elements . GL will not generally recommend against a non-formulaic incentive plan, but will look for a meaningful discussion of the board’s rationale in determining bonuses paid, as well as the rationale for a non-formulaic mechanism, when a company relies primarily on a board’s subjective assessment or discretion in determining short-term bonuses. Where significant issues in a compensation program’s design exist, such as a pay-for-performance disconnect, a lack of payout caps, or a lack of performance-based long-term awards, then the use of a non-formulaic bonus plan may drive a negative say-on-pay recommendation.
Director Voting Recommendations on the Basis of Company Performance . GL will consider a company’s overall corporate governance, pay-for-performance alignment and board responsiveness to shareholders, in addition to stock price performance. If a company’s stock price is in the bottom quartile of the company’s sector, GL will not automatically vote against the company’s director nominees without consideration of the above factors.
D&O Indemnification . GL will support indemnification of directors and officers and/or purchase of liability insurance to cover directors and officers so long as the terms are reasonable.
NOL Protective Amendments . GL has changed its previous policy and will now vote in support of bylaw protective amendments to restrict certain share transfers intended to protect a company’s deferred tax assets, in addition to a vote in support of the adoption of a net operating loss (NOL) poison pill. Previously, GL would oppose the protective amendments while supporting the NOL poison pill.
Quorum Requirements . GL will generally consider a majority of outstanding shares entitled to vote as the appropriate quorum for shareholder meetings. However, GL may support a reduced quorum of at least one-third of shares entitled to vote after considering the specific facts and circumstances of the company (such as the company size and shareholder base).
Other Clarifying Amendments . GL has issued clarifying amendments outside the scope of this alert impacting auditor ratification proposals at business development companies and sufficient disclosure by OTC-listed companies.
[1] 2019 Governance QualityScore (November 26, 2018) may be found at https://www.issgovernance.com/file/products/qualityscore-techdoc.pdf .
[2] 2019 Americas Proxy Voting Guidelines Updates (November 19, 2018) may be found at https://www.issgovernance.com/file/policy/latest/updates/Americas-Policy-Updates.pdf . U.S. Compensation Policies for 2019 (Preliminary FAQs) (November 21, 2018) may be found at https://www.issgovernance.com/file/policy/latest/americas/US-Preliminary-Compensation-FAQ.pdf .
[3] The full text of the 2019 proxy voting guidelines may be found at http://www.glasslewis.com/wp-content/uploads/2018/10/2019_GUIDELINES_UnitedStates.pdf . The 2019 guidelines on shareholder initiatives may be found at http://www.glasslewis.com/wp-content/uploads/2018/10/2019_GUIDELINES_ShareholderInitiatives.pdf .
[4] GL will now consider the state in which the company is headquartered following the adoption of California Senate Bill 826, which was signed into law in September 2018 and requires all companies headquartered in California to have one woman on their board by the end of 2019 and, by the end of 2021, companies must have at least two women on five-member boards and at least three women on boards with six or more directors. A company headquartered in California lacking any women on its board should disclose a clear plan for how it intends to address this issue prior to the end of 2019.
