Institutional Shareholder Services (ISS) recently published updates to its 2016 benchmark U.S. proxy voting guidelines (which ISS also refers to as “policies”). ISS will use these policies for determining its proxy voting recommendations to its institutional investor clients regarding certain matters to be voted on at public company shareholder meetings occurring on or after February 1, 2016. The 2016 benchmark U.S. policy updates can be found here. The updated U.S. policies:

• retain for 2016 the current overboarding limits of six public company boards for non-CEO directors and two outside public company boards for CEOs, but starting February 1, 2017 reduce the non-CEO director limit to five public company boards;

• create separate methodologies for evaluating a board’s post-IPO, unilateral adoption of any bylaw or charter provision that materially diminishes shareholder rights or could adversely impact shareholders and for evaluating adoption of any bylaw or charter provision adverse to shareholders by an issuer or its board prior to or in connection with an IPO, and clarify that, in each such case, ISS will consider such provisions when making director voting recommendations in subsequent years until the provisions are reversed or submitted to a shareholder vote;

• add to the list of problematic pay practices that will generally result in an adverse recommendation on a say-on-pay vote, the failure of externally-managed issuers (EMIs), most of which are REITs, to provide sufficient disclosure to enable shareholders to reasonably assess the compensation arrangements for the EMI’s named executive officers;

• add a framework for evaluating director candidates in contested elections that are nominated through proxy access that is similar to the framework currently used by ISS to analyze proxy contests;

• broaden the current policy regarding shareholder proposals asking issuers to adopt equity retention policies for senior executive officers’ equity compensation received under compensation plans to encompass such proposals more generally and to clarify the factors considered in making voting recommendations; and

• add language to, and clarify the application of, policies on shareholder proposals seeking information on climate change and greenhouse gas emission risks, animal welfare standards and pharmaceutical pricing and access to medicine policies.

U.S. public companies should be aware of the policy updates summarized in this alert. Compliance personnel should consult ISS’ updates and the complete voting policies and related ISS guidance as they become available and share them with their boards or appropriate board committees so the updates can be considered when making governance and compensation decisions and preparing 2016 proxy disclosure.

ISS also recently released updated U.S. equity plan scorecard FAQs, available here. These FAQs discuss a new “Special Cases” model for S&P 500 and Russell 3000 issuers that recently became public or emerged from bankruptcy and do not disclose three years of equity grant data, along with adjustments to certain scorecard factors.

Upcoming ISS Milestones

ISS announced that issuers with annual meetings to be held between February 1, 2016 and September 15, 2016 may submit updated self-selected peer groups used for benchmarking CEO pay until 8 p.m. EST on December 11, 2015. For issuers with annual meetings after September 15, 2016, ISS will conduct a separate peer group update process in mid-2016. Updated peer group information should be provided to ISS by means of its web form, available here. Issuers may want to review ISS’ FAQs on peer group selection methodology, available here.

Public companies should watch for the following ISS actions:

• the release of the complete set of updated ISS voting policies in full and/or summary form in December 2015;

• the release of updated FAQs on certain U.S. policies in December 2015, including FAQs on proxy access proposals; and

• any updates to U.S. summary proxy voting guidelines in January 2016 based on ISS’ evaluation of new U.S. shareholder proposals anticipated for 2016.

Director Overboarding

To allow affected non-CEO directors adequate time to comply with the updated policy, in 2016 ISS will not issue an adverse voting recommendation for a non-CEO director unless such director exceeds the current limit of six public company boards. However, ISS will note in its 2016 research reports if a non-CEO director serves on more than five public company boards. For shareholders meetings held on or after February 1, 2017, ISS will recommend voting “against” or “withhold” for non-CEO directors serving on more than five public company boards (the board of the issuer plus four others).

For 2016, the limit for public company CEOs will remain at two public company directorships in addition to their own company’s board. All boards of an issuer’s subsidiaries that are also public companies on which a CEO serves count against the limit.¹ Despite not changing the CEO limit, ISS noted that it will continue to evaluate that limit and may reconsider it in the future.

ISS will not start making adverse voting recommendations against non-CEO directors under the new five board limit for more than a year. Nevertheless, issuers should:

• identify any of their directors who exceed the five board limit to afford any such director adequate time to carefully decide which board seat(s) to retain and to discuss the matter with his or her other boards and to give an issuer sufficient time to identify and vet a replacement nominee if an overboarded director determines not to stand for reelection to the issuer’s board;

• review any board service limits in their governance guidelines or policies to determine if they should be changed in light of the lower limit that will apply beginning in 2017 and any more restrictive limits in the voting guidelines of the issuer’s major investors; and

• consider for the 2016 proxy season (1) disclosing, where true, that a director will transition off another board so that board will not be counted in assessing the director’s overboarding and (2) differentiating private company and charitable boards from public company boards in director biographies to avoid the appearance of overboarding.

Unilateral Bylaw/Charter Amendments

For existing public companies, if an issuer’s board unilaterally amends the issuer’s bylaws or charter in a manner that materially diminishes shareholder rights or that could adversely impact shareholders, ISS will generally recommend voting “against” or “withhold” for individual directors, committees or the entire board after considering certain factors, which factors remain virtually unchanged from 2015. In subsequent years, ISS will make director voting recommendations on a case-by-case basis until the “adverse” amendment is reversed or submitted to a binding shareholder vote. However, ISS will generally recommend an “against” vote for directors where the amendment:

• classifies the board;

• imposes supermajority voting requirements to amend the bylaws or charter; or

• removes shareholders’ ability to amend the bylaws.

If, prior to or in connection with their IPO, a newly public company or its board adopts bylaw or charter provisions that are adverse to shareholder rights, ISS will generally recommend voting “against” or “withhold” for directors after considering the following factors:

• the level of impairment of shareholder rights caused by the provision;

• the issuer’s or the board’s rationale for adopting the provision;

• the provision’s impact on the shareholders’ ability to change the governance structure in the future (e.g., limitations on shareholder rights to amend the bylaws or charter or supermajority vote requirements to amend the bylaws or charter);

• the shareholders’ ability to hold directors accountable through annual director elections or whether the issuer has a classified board structure; and

• any public commitment to put the adverse provision to a shareholder vote within three years of the IPO.

In subsequent years, ISS will make director voting recommendations on a case-by-case basis until the adverse provision is reversed or submitted to a public shareholder vote. Although ISS does not specify that such a vote must be binding in the case of newly public companies, issuers are best advised to consider the policy to require such a vote be a binding shareholder vote unless ISS clarifies that it intends otherwise.

In light of these updates, boards of existing public companies or boards of private companies considering or in the process of going public should carefully weigh whether to unilaterally adopt amendments to the bylaws or charter that materially diminish shareholder rights or that could adversely impact shareholders.² Although boards should take actions that they believe are in the best interests of the issuer and its shareholders, the adoption of unilateral amendments that ISS decides materially diminish or adversely impact shareholder rights, especially those that classify the board, establish supermajority vote requirements to amend the bylaws or charter or remove shareholders’ right to amend the bylaws, could result in an adverse ISS voting recommendation.

To avoid the potential adverse voting recommendation, boards adopting pre-IPO, shareholder-adverse amendments should consider seeking ratification of the specified amendments at their first post-IPO annual shareholders’ meeting or making a public commitment in their first post-IPO proxy statement to seek shareholder ratification within three years of the IPO. However, issuers obtaining shareholder ratification of such a shareholder-adverse amendment should keep in mind that the ratification will not immunize an issuer against ISS taking such a charter or bylaw provision into account when determining other voting recommendations in the future.

EMI Compensation Disclosures

Although required to hold periodic say-on-pay votes, EMIs typically do not directly compensate the persons deemed to be their named executive officers. Instead, those persons, who are typically employees of an EMI’s external manager and not of the EMI, are typically compensated by the EMI’s external manager, which is reimbursed for that compensation by the EMI via a management fee. According to ISS, EMIs often do not disclose details about the compensation arrangements of their named executive officers and the compensation information that is disclosed is typically limited to the aggregate management fee paid by the EMI to its external manager. ISS is concerned that without sufficient disclosure of the compensation of the EMI’s named executive officers, shareholders lack the information necessary to make an informed voting decision on an EMI’s say-on-pay proposal.

ISS has updated its problematic pay practice policy to add to its list of such practices insufficient compensation disclosure by EMIs. ISS has also included a new voting guideline pursuant to which it will generally recommend voting “against” an EMI’s say-on-pay proposal in the event insufficient compensation disclosure by an EMI precludes a reasonable assessment of the pay programs and practices applicable to the EMI’s named executive officers.

Although ISS will have the discretion to determine what constitutes “sufficient” compensation disclosure, EMIs should review their existing compensation disclosure and consider how it could be enhanced to minimize the likelihood that it would be deemed insufficient by ISS. ISS did not provide any guidance as to what constitutes sufficient disclosure. However, based on ISS’ discussion of the new policy, EMIs should consider, at a minimum, whether there is enough disclosure to allow investors to understand the compensation arrangements and payments made by the external managers to the persons who are deemed to be the named executive officers of the EMIs and the compensation philosophy of the external manager. In noting that some EMIs disclose the aggregate portion of the management fee allocable to executive compensation expenses, ISS appears to suggest that such disclosure is “in sufficient detail.” Nevertheless, an EMI whose named executive officers participate in a compensation program under which the officers are granted or can acquire newly issued equity of the EMI that is not already including detailed disclosure regarding that equity compensation in its proxy statements used to solicit proxies regarding say-on-pay proposals should consider providing that disclosure in its future proxy statements used to solicit proxies as to a say-on-pay proposal.

Proxy Access Director Nominations

Where a shareholder nominates a director pursuant to a proxy access right, ISS will make voting recommendations on a case-by-case basis considering the factors it currently considers for contested elections and any other relevant factors, including those that are specific to:

• the issuer;

• the nominee(s); or

• the nature of the election (for example, whether the candidates exceed the available board seats).

ISS will issue FAQs in December 2015 that provide more detail about this updated policy and information on those provisions of proxy access proposals, whether proposed by management or shareholders, that ISS considers overly restrictive.

Executive Equity Retention Policies

ISS will make voting recommendations on a case-by-case basis for shareholder proposals asking issuers to adopt policies requiring senior executive officers to retain a portion of the net shares received under compensation plans after considering the following factors:

• the required percentage/ratio of net shares to be retained;

• the required retention period;

• whether the issuer has implemented equity retention, holding period or stock ownership requirements and the robustness of such requirements;

• whether the issuer has any other policies aimed at mitigating executive risk taking;

• executives’ actual stock ownership and the degree to which it meets or exceeds the shareholder proponent’s suggested holding period/retention ratio or the issuer’s existing requirements; and

• past and current problematic pay practices that may demonstrate a short-term versus long-term focus.

ISS has significantly broadened this policy to encompass any shareholder proposals seeking adoption of a policy requiring retention of any amount of net shares received by senior executive officers. This update eliminates ISS’ need to maintain its separate existing policy tied to a specified retention ratio and eliminates the prior policy’s application to only those proposals requiring retention for a period or periods described in the prior policy. Moreover, the updated policy no longer includes a guideline for the type of retention requirement for CEOs and other executive officers that ISS will consider rigorous or robust.

Issuers should review their equity retention policies to determine whether they should make changes to those policies to forestall new equity retention policy proposals that this ISS policy update may prompt shareholders to make.

Environmental and Social Issues

Updated climate change/greenhouse gas emissions policy. ISS has added language to this policy, which provides that ISS will generally recommend voting for shareholder proposals asking an issuer to disclose climate change risks, to clarify (1) the types of climate change risks that ISS believes can impact an issuer’s operations and investments (for example, financial, physical and regulatory risks) and (2) that the policy applies to proposals addressing an issuer’s fossil fuel-related capital expenditure strategies and stranded carbon asset risk.

Updated animal welfare policy. ISS has added language to this policy, which provides that ISS will generally recommend voting for shareholder proposals seeking an issuer report on its animal welfare standards unless a list of conditions is satisfied, to clarify that the policy also applies to proposals seeking a report on animal welfare-related risks and to add to the factors considered in making the recommendation, the presence of significant fines, litigation or controversies relating to the treatment of animals by an issuer’s suppliers.

Updated pharmaceutical pricing and access to medicines policy. ISS has added language to this policy, which provides that ISS will make case-by-case voting recommendations for shareholder proposals seeking an issuer report on its pharmaceutical product pricing or access to medicine policies after considering a number of listed factors, to codify in those factors ISS’ existing practice of considering the potential for regulatory risks and the issuer’s recent exposure to controversies, litigation or fines.

_{1. However, ISS will not recommend a withhold vote from the CEO of a parent company board or any of the controlled (i.e., greater than 50 percent ownership) subsidiaries of that parent, but may do so at the issuer’s subsidiaries that are less than 50 percent controlled and boards outside the parent/subsidiary relationships.}

_{2. Although ISS will make the ultimate determination of whether a unilateral amendment is deemed to materially diminish shareholder rights or adversely affect shareholders or is adverse to shareholders, ISS has previously provided examples of amendments that it would and would not deem materially adverse. See ISS, 2015 Benchmark U.S. Proxy Voting Policies Frequently Asked Questions on Selected Topics, Question 4 (Feb. 19, 2015), available at http://www.issgovernance.com/file/policy/2015faquspoliciesonselectedtopics.pdf.}