Institutional Shareholder Services ("ISS") and Glass, Lewis & Co., Inc. ("Glass Lewis"), the two major proxy advisory firms, recently released updates to their proxy voting policies for the 2013 proxy season. The ISS U.S. Corporate Governance Policy 2013 Updates (the "ISS Policy Updates"), which are available at http://issgovernance.com/policy/2013/policy_information, apply to shareholder meetings held on or after February 1, 2013. ISS also has released updated Frequently Asked Questions (the "ISS FAQs"), available at the link above, relating to its 2013 policies. The Glass Lewis Proxy Paper Guidelines for the 2013 Proxy Season (the "Glass Lewis Guidelines") will be effective for annual meetings held on or after January 1, 2013. A summary of the updates to the Glass Lewis Guidelines is available here. This alert reviews the most significant ISS and Glass Lewis updates and suggested steps for companies to consider in light of these updated proxy voting policies.
I. ISS Policy Updates
A. Board Issues
Board Response to Majority-Supported Shareholder Proposals. ISS currently recommends votes against the entire board (except new nominees, who are considered case-by-case) if the board failed to act on a proposal that (1) received the support of a majority of shares outstanding in the previous year, or (2) received the support of a majority of shares cast in the last year and one of the two years prior to that. As a result of the ISS Policy Updates, starting with results from 2013 annual meetings, ISS will recommend votes against individual directors, committee members, or the entire board, as it deems appropriate, if the board failed to act on a shareholder proposal that received the majority of shares cast in the previous year. For 2013 annual meetings, ISS will not apply this new standard but will make voting recommendations based on its current policy.
Under the ISS Policy Updates, if the company's response to the shareholder proposal involves less than full implementation of the shareholder proposal, ISS will consider the response on a case-by-case basis, taking into account:
- the subject matter of the proposal;
- the level of support and opposition to the resolution in past meetings;
- disclosed outreach efforts by the board to shareholders in light of the vote;
- actions taken by the board in response to its engagement with shareholders;
- whether the underlying issue appears as a voting item on the ballot (as either shareholder or management proposals); and
- other factors as appropriate.
ISS applied these factors on a less formal basis in at least one instance in 2012 (for Amgen Inc.'s 2012 annual meeting), in evaluating company responses to majority-supported shareholder proposals.
The ISS FAQs include additional guidance about how ISS will apply these factors to specific types of proposals. For example:
- in response to an independent chair proposal, a policy that a company will adopt an independent chair structure upon the resignation of its current CEO would be "highly responsive";
- in response to a proposal requesting majority voting in director elections, adopting a director resignation policy instead of a true majority vote standard generally would not be a sufficient response; and
- in response to a written consent proposal, a company may implement the right with "reasonable restrictions," including: (1) an ownership threshold of 10 percent or less; (2) no restrictions on agenda items; (3) a total review and solicitation period of no more than 90 days; (4) limits on when written consent may be used of no more than 30 days after a meeting already held or 90 days before a scheduled meeting; and (5) a requirement that the soliciting shareholders use best efforts to solicit consents from all shareholders; ISS will evaluate other restrictions in light of the company's disclosure of its shareholder outreach to determine what shareholders consider reasonable and the company's equity structure, among other things.
Board Accountability – Significant Pledging of Company Stock. ISS currently recommends votes against individual directors, committee members, or the entire board in extraordinary circumstances, such as situations involving "material failures of governance, stewardship, risk oversight, or fiduciary responsibilities at the company." Under the ISS Policy Updates, ISS will now consider significant pledging of company stock to be a failure of risk oversight that may warrant voting recommendations against individual directors, committee members, or the entire board. According to the ISS FAQs, ISS will determine whether a level of pledging is "significant" on a case-by-case basis by assessing the aggregate pledged shares relative to shares outstanding, market value, or trading volume.
In determining voting recommendations for the election of directors at companies that have executives or directors with pledged company stock, ISS will take a case-by-case approach, taking into account the following factors:
- proxy disclosure of an anti-pledging policy that prohibits future pledging;
- the magnitude of aggregate pledged shares relative to total common shares outstanding, market value or trading volume;
- disclosure of progress or lack of progress in reducing the magnitude of aggregate pledged shares over time;
- proxy disclosure that shares subject to stock ownership and holding requirements do not include pledged company stock; and
- any other relevant factors.
The ISS FAQs indicate that, in order to mitigate a negative vote recommendation, an executive or director who has pledged a significant amount of company stock should reduce the aggregate pledged shares over time, and the company should adopt (and disclose in the proxy statement) a policy prohibiting future pledging.
The ISS Policy Updates also identify hedging as a failure of risk oversight, and "any" amount of hedging "will be considered a problematic practice warranting a negative voting recommendation."
Director Attendance at Board and Committee Meetings. Under its current policy, ISS recommends votes against the entire board where the company's proxy disclosure indicates that not all directors attended at least 75% of the aggregate board and committee meetings without disclosing the directors involved. Under the ISS Policy Updates, ISS will recommend votes against the individual director or directors in question where it is unclear whether the director attended, or where the director did not attend, at least 75% of the aggregate of the board and committee meetings during the period for which the director served, unless the proxy or another SEC filing discloses "acceptable" reasons for the absences. Such reasons generally are limited to: (1) medical issues/illness; (2) family emergencies; and (3) missing only one meeting, when the total number of all meetings is three or fewer. ISS will consider new nominees case-by-case and will take into account any schedule conflicts due to commitments made prior to their appointment to the board, if disclosed in the proxy or another SEC filing.
Overboarded Directors. ISS currently recommends votes against individual directors who sit on more than a total of six public company boards, or are public company CEOs who serve on more than two public company boards in addition to their own (in which case ISS will issue an against recommendation only at the CEO's outside boards). Under the ISS Policy Updates, ISS will count all subsidiaries with publicly traded stock as separate boards. (Subsidiaries that issue only debt will not count.) This is a change from the current policy, which includes subsidiary boards as part of the parent company board if a subsidiary is at least 20 percent-owned. However, for public company CEOs, ISS will count the boards of controlled (at least 50 percent-owned) subsidiaries and affiliates as part of the parent company board in calculating the number of the CEO's outside boards.
Categorization of Directors. The ISS Policy Updates streamline ISS's definition of an "inside director," which is now defined as follows:
- Current employee or current officer of the company or one of its affiliates.
- Director named in the Summary Compensation Table (excluding former interim officers).
- Beneficial owner of more than 50 percent of the company's voting power, which may be aggregated if voting power is distributed among more than one member of a group (which is not a change from the current "inside director" definition).
B. Executive Compensation
Pay-for-Performance Evaluation. ISS annually conducts a two-step pay-for-performance analysis. First, ISS performs a quantitative analysis that measures performance relative to an ISS-created peer group and incorporates an absolute performance component related to the company's total shareholder return ("TSR"). If the quantitative analysis demonstrates significant unsatisfactory long-term pay-for-performance alignment (or, in the case of non-Russell 3000 index companies, otherwise suggests misaligned pay and performance), ISS analyzes qualitative factors to determine how various pay elements may encourage or undermine long-term value creation and alignment with shareholder interests.
The ISS Policy Updates include updates to ISS's pay-for-performance methodology. The updated methodology is detailed in the ISS pay-for-performance white paper, available at http://www.issgovernance.com/sites/default/files/evaluatingpayforperformance.pdf, which ISS published in December 2012 and updated in January 2013.
Under the ISS Policy Updates, ISS is revising its methodology for determining the peer group used to perform its quantitative pay-for-performance evaluation. In determining a company's peer group, ISS's new methodology will incorporate information from the company's self-selected peer group used for pay benchmarking, as disclosed in the company's proxy statement. ISS will start by creating a "seed group" of peers that includes all companies within the company's 4- and 6-digit Global Industry Classification Standard ("GICS") groups. Once the seed group is formed, ISS will draw peers from the seed group based on a specified order of priority, focusing primarily on the company's own 8-digit GICS group, then on the "underrepresented" GICS groups from the company's self-selected peers (i.e., where the proportion of peers in that GICS group is less than 1.15 times the proportion in the company's self-selected peer group). ISS aims to generate a peer group of between 14 and 24 companies in which the subject company is within 15 percent of the median size of the ISS peer group. Thus, when selecting peers, ISS will prioritize peers that maintain the company size near the median of the peer group, are in the company's own peer group, and that have chosen the company as one of their own peers. The methodology will maintain its focus on identifying companies that are reasonably similar to a company in terms of industry profile, size, and market capitalization.
Under the ISS Policy Updates, ISS also will include in the research reports for S&P 500 companies a comparison of three-year realizable pay to three-year grant date pay. In addition, a discussion of realizable pay generally will be included in the qualitative analysis for S&P 500 companies where the initial quantitative analysis shows a high or medium concern regarding pay-for-performance. For these companies, if the total pay granted during a three-year measurement period is significantly higher or lower than its realizable value at the end of that period, ISS will analyze and consider the cause of this disconnect as part of its qualitative pay-for-performance analysis.
Realizable pay, under the ISS definition, will be calculated based on a specified measurement period (generally three fiscal years, as reported in the Company's Summary Compensation Table) and will consist of the sum of base salary, bonus, short-term (annual) awards, the earned value or target value of long-term awards (based on stock price as of the end of the measurement period for share-based awards, and depending on whether the applicable performance period is completed within the measurement period), the Black-Scholes value (or, with respect to exercised stock options, the net value realized) of stock options granted during the measurement period, change in pension value and nonqualified deferred compensation earnings, and all "other" reported compensation. ISS notes that the realizable pay consideration may mitigate or exacerbate pay-for-performance concerns and that realizable pay that demonstrates a pay-for-performance philosophy will be a positive consideration.
During an ISS webcast on the global 2013 proxy voting policy updates held on December 6, 2012, ISS indicated that in the future it may expand the realizable pay analysis to cover a broader group of companies.
Company Golden Parachutes. Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, companies must hold separate shareholder votes on potential golden parachute payments when they seek shareholder approval for mergers, sales, and certain other transactions. ISS currently recommends votes on a case-by-case basis on proposals to approve a company's golden parachute compensation, consistent with ISS's policies on problematic pay practices related to severance packages, considering a number of features that may lead to an against vote.
Under the ISS Policy Updates, ISS will: (1) begin to consider existing change-in-control arrangements maintained with named executive officers, rather than focusing only on new or extended arrangements; and (2) place further scrutiny on "multiple legacy problematic features" in change-in-control agreements. This change in policy will likely result in ISS recommending against a greater number of company golden parachute proposals than in the past.
With respect to the second prong above, ISS's new policy notes that recent amendments incorporating problematic pay features will carry more weight in ISS's overall analysis of golden parachute proposals, but that the presence of multiple legacy problematic features also will be closely scrutinized. Features that may result in a negative vote recommendation include: (1) single- or modified single-trigger cash severance; (2) single-trigger acceleration of unvested equity awards; (3) excessive cash severance (i.e., greater than three times base salary and bonus); (4) excise tax gross-ups triggered and payable (as opposed to a provision to provide excise tax gross-ups); (5) excessive golden parachute payments (on an absolute basis or as a percentage of transaction equity value); (6) recent amendments that incorporate any problematic features (such as those listed in (1) through (5)) or recent actions (such as extraordinary equity grants) that may make packages so attractive as to influence merger agreements that may not be in the best interests of shareholders; or (7) the company's assertion that a proposed transaction is conditioned on shareholder approval of the golden parachute advisory vote.
C. Social/Environmental Issues
Non-Compensation-Related Social and Environmental Shareholder Proposals. ISS currently evaluates social and environmental shareholder proposals case-by-case, considering a variety of factors. Under the ISS Policy Updates, ISS provides overarching principles to be applied to these proposals in all global markets and streamlines the factors that it considers in evaluating such proposals. ISS generally will vote case-by-case on environmental and social shareholder proposals, taking into account whether implementation of the proposal is likely to enhance or protect shareholder value, as well as the following factors:
- whether the issues presented in the proposal are more appropriately or effectively dealt with through legislation or government regulation;
- whether the company has already responded in an appropriate and sufficient manner to the issues raised in the proposal;
- whether the proposal's request is unduly burdensome (in scope, timeframe, or cost) or overly prescriptive;
- the company's approach, in comparison to any industry standard practices for addressing the issues raised by the proposal;
- if the proposal requests increased disclosure or greater transparency, whether or not reasonable and sufficient information is currently available to shareholders from the company or from other publicly available sources; and
- if the proposal requests increased disclosure or greater transparency, whether or not implementation would reveal proprietary or confidential information that could place the company at a competitive disadvantage.
Compensation-Related Environmental, Social, and Governance (ESG) Shareholder Proposals. Under its current policy, ISS generally recommends votes against proposals to link, or requesting a report on linking, executive compensation to environmental and social criteria, such as corporate downsizings, customer or employee satisfaction, community involvement, human rights, environmental performance, or predatory lending.
Under the ISS Policy Updates, ISS now will recommend votes on proposals to incorporate sustainability (environmental and social) criteria on a case-by-case basis, rather than generally recommending votes against. In this regard, ISS notes that companies in certain sectors, including the extractive industry sector, increasingly are incorporating sustainability metrics in executive compensation. In evaluating these proposals, ISS will continue to consider substantially similar factors to those it currently takes into account:
- whether the company has significant and/or persistent controversies or violations regarding social and/or environmental issues;
- whether the company has management systems and oversight mechanisms in place regarding its social and environmental performance;
- the degree to which industry peers have incorporated similar non-financial performance criteria in their executive compensation practices; and
- the company's current level of disclosure regarding its environmental and social performance.
Lobbying Shareholder Proposals. The ISS Policy Updates clarify that the ISS voting policy regarding lobbying proposals applies not only to proposals addressing lobbying activities, but also to proposals on lobbying policies and procedures, and on indirect and grassroots lobbying. ISS will continue to evaluate lobbying proposals on a case-by-case basis, taking into account:
- the company's current disclosure of relevant policies and oversight mechanisms;
- recent significant controversies, fines, or litigation regarding the company's lobbying-related activities; and
- the impact that any specific public policy issues addressed in the proposal may have on the company's business operations.
D. Other ISS Developments: New Governance Risk Scoring Methodology
ISS currently uses the Governance Risk Indicators ("GRId") methodology to evaluate and rate public companies' practices and governance-related risk levels across four categories of corporate governance: board of directors, executive compensation, audit, and shareholder rights. Companies' GRId scores are published in ISS proxy research reports and posted on companies' Yahoo! Finance profile websites. Starting in late February or early March 2013, ISS will replace GRId with the ISS Governance QuickScore, a new methodology to identify governance risks. According to ISS, QuickScore is similar to GRId but differs in the following respects:
- the new quantitatively-driven methodology focuses on "correlations between governance factors and key financial metrics" with a secondary policy-based focus on qualitative aspects of governance;
- QuickScore will continue to score companies based on the same four categories of governance practices, but, instead of GRId's color-coded levels of concern, QuickScore will report a company's governance risk score on a numeric scale and, later in the year, will also score companies relative to industry sector; and
- QuickScore initially will cover 4,100 companies in 25 markets, including the 3,000 largest U.S. companies based on market capitalization.
The new QuickScore Technical Document is available at www.issgovernance.com/quickscore. From now through February 15 (and also after QuickScore is launched in late February or early March), companies within the QuickScore universe will have access to ISS's data verification website to review the data collected by ISS on the QuickScore factors. Covered companies' ISS proxy research reports will include the new QuickScore data when QuickScore is launched in late February or early March.
II. Glass Lewis Guidelines Updates
Board Responsiveness to a Significant Shareholder Vote. The Glass Lewis Guidelines add a new policy regarding board responsiveness to any proposal receiving a shareholder vote of 25% or more against the company's recommendation. Under this policy, when 25% or more of votes cast (excluding abstentions and broker non-votes) oppose the company's recommendation on any proposal, Glass Lewis will evaluate the board's responsiveness to the vote on a case-by-case basis. It will review the company's publicly available disclosures and take into account:
- at the board level, any changes in directorships, committee memberships, disclosure of related party transactions, meeting attendance or other responsibilities;
- any revisions made to the company's certificate of incorporation, bylaws, or other governance documents;
- any press or news releases indicating changes in, or the adoption of, new company policies, business practices or special reports; and
- any modifications made to the design and structure of the company's compensation program.
If Glass Lewis determines that the board did not respond appropriately, Glass Lewis may recommend votes against director nominees or oppose the board's voting recommendation on related company proposals.
Overboarded Directors. Glass Lewis generally recommends votes against a director nominee who serves as an executive officer of any public company while serving on more than two other public company boards. The Glass Lewis Guidelines clarify that Glass Lewis will recommend votes against the director only at the other public companies where the director serves on the board, and not at the company where the director serves as an executive officer.
Exclusive Forum Provisions. Under the Glass Lewis Guidelines, Glass Lewis generally will continue to recommend votes against any proposal to amend the certificate or bylaws to adopt an exclusive forum provision limiting shareholders' rights to bring legal claims in a specific jurisdiction. However, the Guidelines indicate that Glass Lewis may support such a proposal in certain cases, if the company: (1) offers a compelling argument as to why the exclusive forum provision would directly benefit shareholders; (2) provides evidence of abuse of legal process in other, non-favored jurisdictions; and (3) maintains a strong record of "good corporate governance practices."
Other Updates. The Glass Lewis Guidelines also include updates that address (1) the application of the Guidelines that call for Glass Lewis to recommend votes "against" a board committee chair when there is no committee chair or the committee chair is not up for election; (2) counting shares in equity compensation plans in ways that understate the potential dilution or cost to shareholders; and (3) the issuance of preferred stock at real estate investment trusts ("REITs").
Executive Compensation. In July 2012, Glass Lewis updated its peer group selection methodology used to evaluate pay-for-performance for purposes of voting recommendations on company say-on-pay proposals. For annual meetings held on or after July 1, 2012, Glass Lewis will use a peer group approach developed by Equilar, which is based on market data and social analytics. Under this approach, the analysis starts with the company's own disclosed peers and examines the strength of the relationships between these companies to create a peer group of those companies with the strongest relationships.
New Proxy Paper. Glass Lewis also recently announced that, beginning in early February, it will introduce updates to its "Proxy Paper" reports, including: (1) a new cover page that will highlight relevant information, including "issues of concern"; (2) an "ownership profile" section; (3) a "company profile" section that provides important company information; (4) a proposal summary at the beginning of every proposal analysis that summarizes historical voting results and key issues of concern; and (5) a streamlined presentation format for the proposal analysis that uses reader-friendly formats, such as charts and bullet points.
What Companies Should Do Now
Given ISS's influence, and Glass Lewis's growing influence, over voting results, companies should assess their practices and disclosures against the criteria and factors described in the voting policies. While companies need to be aware of these policies, boards of directors must act in a manner consistent with their fiduciary duty to act in the best interest of the company. In many cases, the extent to which a company recognizes an issue and proactively addresses the concern in its disclosures and discussions with its shareholders can make a significant difference in the content of ISS's and Glass Lewis's analysis and, at times, their voting recommendation. For example, in recent proxy seasons ISS proxy voting recommendations have had a significant impact on the level of support for independent chair shareholder proposals, and ISS's voting recommendations often depend on whether a company has a lead independent director that performs the duties specified in the ISS policy.
In light of the policy updates, companies should begin to:
- For S&P 500 companies, consider whether to include "realizable" pay in the proxy statement and, if so, consider the extent to which the company should use the ISS definition.
- In addressing shareholder proposals for this proxy season, be mindful that the new ISS policy on majority-supported shareholder proposals will take effect starting in 2014.
- Consider enhanced shareholder engagement to ascertain shareholder views on company and shareholder proposals anticipated for this proxy season and disclose such efforts.
- Consider additional shareholder solicitation efforts as appropriate.
- Consider whether any directors will be "overboarded" under the ISS Policy Updates due to serving on the boards of publicly traded subsidiaries.
- If any director or executive has pledged a significant amount of company stock, consider adopting and disclosing a policy prohibiting future pledging and suggesting that the director or executive reduces the aggregate pledged shares over time.
- Consider adopting a policy prohibiting the hedging of company stock.
Gibson, Dunn & Crutcher's lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you work, or any of the following:
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Brian J. Lane - Washington, D.C. (202-887-3646, email@example.com)
Ronald O. Mueller - Washington, D.C. (202-955-8671, firstname.lastname@example.org)
Amy L. Goodman - Washington, D.C. (202-955-8653, email@example.com)
Stephen W. Fackler - Palo Alto, CA (650-849-5385, firstname.lastname@example.org)
James J. Moloney - Orange County, CA (949-451-4343, email@example.com)
Elizabeth Ising - Washington, D.C. (202-955-8287, firstname.lastname@example.org)
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