November 22, 2016
The two most influential proxy advisory firms–Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis)–recently released their updated proxy voting guidelines for 2017. The key changes to the ISS and Glass Lewis policies are described below along with some suggestions for actions public companies should take now in light of these policy changes and other proxy advisory firm developments. The 2017 ISS policy updates are available here. The 2017 Glass Lewis Guidelines are available here.
On November 21, 2016, ISS released updated proxy voting policies for shareholder meetings held on or after February 1, 2017. These policies are used by ISS in making voting recommendations on director elections and company and shareholder proposals at U.S. companies. The changes in the 2017 proxy voting guidelines are described below.
ISS also indicated that it plans to issue updated FAQs on equity plan proposals (discussed below) and other matters in mid-December, and that it plans to issue updated voting policies on shareholder proposals anticipated for 2017 annual meetings in January 2017.
As announced in the ISS 2016 Proxy Voting Policy Updates, ISS will begin recommending votes "against" directors who sit on more than five public company boards. Prior to this announcement and during the 2016 transition period, the maximum number of boards a director could sit on without receiving a negative ISS voting recommendation was six. The recommendations for public company CEOs remain unchanged: ISS will continue to recommend votes "against" public company CEOs who sit on the boards of more than two public companies besides their own (but only at those companies where the CEO is a director, not on the CEO’s own board).
ISS now will recommend votes "against" members of the governance committee if a company’s charter places "undue" restrictions on shareholders’ right to amend the company’s bylaws. Undue restrictions include, but are not limited to, prohibitions on the submission of binding shareholder proposals or ownership requirements in excess of those imposed by Rule 14a-8. ISS will continue to issue negative voting recommendations each year that these restrictions remain in place. Prior to this update, ISS did not have a stated position on this issue.
ISS now will generally recommend votes "against" all directors other than new nominees if a company completes an IPO with a multi-class capital structure in which the classes do not have equal voting rights. Prior to this update, ISS recommended votes "against" directors of IPO companies if the company had provisions in its charter or bylaws that were "materially adverse" to shareholder rights, and ISS provided a list of factors that could change the presumption of a negative voting recommendation, including a public commitment to put the adverse provision to a shareholder vote within three years of the date of the IPO.
Under the new guidance, if, prior to the IPO, the company or its board adopted charter or bylaw provisions materially adverse to shareholder rights, or implemented a multi-class capital structure in which the classes have unequal voting rights, ISS will recommend a vote "against" all directors except new nominees, unless there is a reasonable sunset provision (i.e., a commitment to hold a shareholder vote within three years will no longer be sufficient). In addition to the sunset provision, as under its current policy, ISS will continue to consider a list of factors in making its final voting recommendation. In addition, unless the adverse provision and/or problematic capital structure is reversed or removed, ISS will recommend votes case by case on director nominees in subsequent years.
ISS has a voting policy that specifically addresses common stock authorizations in connection with a stock split or stock dividend, and it has clarified this policy for 2017. In connection with a planned stock split or stock dividend, a company may need to increase the number of authorized shares of its common stock, which would require shareholder approval. The company may seek approval for a total number of shares that exceeds the number it anticipates distributing in connection with the stock split or stock dividend. As updated, the ISS policy now makes clear that ISS will generally vote "for" these proposals as long as the "effective" increase in authorized shares satisfies ISS’s common stock authorization policy. As we understand it, this clarification means that, in evaluating the impact of the increase on a company’s authorized share capital, ISS will continue to consider only the number of excess shares–that is, shares over and above those to be issued as a planned stock split or stock dividend.
ISS has changed aspects of its "Equity Plan Scorecard," which is part of its proxy voting policy for equity-based incentive plans. Specifically, ISS has added a factor to the Equity Plan Scorecard that considers whether dividends or dividend equivalents related to an equity award can be payable prior to vesting of the award. Under the new factor, equity plans that explicitly prohibit the payment of all dividends or dividend equivalents before the vesting of the underlying equity award will receive full credit, while companies will receive no credit if the prohibition is "absent or incomplete" (that is, it does not apply to all types of awards). A company’s general practice to withhold dividends during the vesting period is insufficient to receive credit under the Equity Plan Scorecard if the policy is not made explicit in the equity plan document. A provision that allows the accrual of dividends/dividend equivalents payable upon vesting is sufficient as long as dividends are withheld during the vesting period.
In addition to adding the new factor, ISS has also changed the factor in the Equity Plan Scorecard related to minimum vesting periods. Under the updated factor, in order to receive full credit, an equity plan must specify a minimum vesting period of at least one year that applies to all award types and that cannot be overridden in individual award agreements. This is a change from the prior version of the factor, which only required that the minimum vesting period apply to one type of award and was silent with respect to individual award agreements.
ISS clarified how it will evaluate proposals to amend cash or equity incentive plans by more clearly differentiating the framework it will apply to various types of amendments. ISS’s recommendation on amendments to all plans (whether cash, stock, or a combination of the two) that only seek shareholder approval of performance metrics for Section 162(m) purposes (other than in connection with the first such approval following an IPO) will depend on whether the board committee administering the plan consists entirely of independent directors. Note that for these purposes ISS applies its definition of "independence", not the applicable New York Stock Exchange or NASDAQ definition. All other cash and equity plan amendments will receive recommendations on a case-by-case basis. The amendments do not substantively change the ISS policy; they merely clarify its application.
Separately, ISS also recently announced that it would incorporate an additional proprietary financial performance metric into the pay-for-performance analysis it uses in evaluating a company’s executive compensation and say-on-pay proposal. When evaluating executive compensation, ISS currently applies a quantitative screen that uses three metrics: (a) the degree of alignment between the company’s annualized total shareholder return (TSR) and the CEO’s annualized total awarded compensation, each measured on a relative basis within a peer group and over a three-year period; (b) the degree of absolute alignment between the trend in CEO pay and the company’s TSR over the prior five fiscal years; and (c) the multiple of the CEO’s total awarded compensation relative to the peer group median CEO total compensation. This quantitative screen is intended to flag companies where a potentially significant misalignment of pay and performance may exist and therefore where further assessment is warranted in the form of a qualitative pay-for-performance analysis.
Based on feedback obtained through its 2016 policy survey, ISS has announced that it will incorporate an additional pay-for-performance metric into its analysis beginning in 2017. Specifically, ISS has developed a new metric that compares the relative degree of alignment between the CEO’s annualized total awarded compensation and the company’s performance as calculated by ISS based on six financial metrics, with both compensation and financial performance being measured relative to an ISS-selected peer group over a three-year period. The six financial performance metrics that will be used in this analysis are (a) return on invested capital, (b) return on assets, (c) return on equity, (d) revenue growth, (e) EBITDA growth, and (f) growth in cash flow from operations. The weight that ISS places on each of these six metrics will vary by industry for purposes of producing the new numerical weighted financial performance metric. Beginning in 2017, ISS’s voting recommendation reports will present this information in a new standardized table that sets forth the company’s three-year performance based on TSR and on these six financial metrics relative to the company’s ISS selected peer group, compares performance on these metrics with relative compensation levels (in each case, relative to the ISS selected peer group), and presents the overall weighted financial performance metric. Companies that subscribe to ISS’s executive compensation services will be able to view online projections of their relative financial performance evaluation under these new measures.
For 2017, ISS stated that it may use the relative financial performance information in the qualitative aspect of its pay-for-performance analysis. Thus, no changes are being made for 2017 to ISS’s quantitative pay-for-performance analysis, although ISS is leaving the door open for changes in 2018 and beyond. As with any standardized measure, some companies may object that the new financial performance measures utilized by ISS do not accurately portray their performance, and may object to the manner in which ISS weights the various financial performance measures. The extent of these objections, and the extent to which shareholders embrace the ISS presentations, may well depend on the extent of transparency that ISS provides into its proprietary financial performance calculations and to the weight it assigns to each.
ISS has added a new policy for evaluating company proposals seeking ratification of non-employee director compensation. ISS will vote case by case on these proposals, based on a list of factors. The list of factors includes director compensation at comparable companies, the presence of "problematic" pay practices relating to director compensation, director stock ownership guidelines and holding requirements, equity award vesting schedules, the mix of cash and equity-based compensation, "meaningful" limits on director compensation, the availability of retirement benefits, and the quality of disclosure surrounding director compensation. ISS will also consider whether or not the equity plan under which non-employee director grants are made warrants support, if that plan is up for shareholder approval. This policy is being implemented in reaction to shareholder litigation over director compensation and the ensuing shareholder ratification proposals put forth by companies.
ISS modified the factors considered when it evaluates equity compensation plans that apply solely to non-employee directors. ISS will continue to evaluate plans on a case by case basis based on the estimated cost of the plan relative to peer companies, the company’s three-year burn rate relative to peer companies, and plan features. In cases where director stock plans exceed ISS plan cost or burn rate benchmarks, in making its recommendation, ISS will continue to consider various factors relating to director compensation in formulating its voting recommendation. However, rather than requiring that a company’s director compensation program meet certain enumerated criteria, which is the approach under ISS’s current policy, ISS will "look holistically" at all of the factors. In addition, ISS has updated and expanded these factors so they are the same factors used in ISS’s new policy for evaluating company proposals seeking shareholder ratification of director compensation programs.
On November 18, 2016, Glass Lewis released their updated proxy voting policy guidelines for 2017 in the United States and for shareholder proposals. These guidelines are a detailed overview of the key policies Glass Lewis applies when making voting recommendations on proposals at U.S. companies and on shareholder proposals. The four key changes in these 2017 guidelines are summarized below.
As previously announced, beginning in 2017 Glass Lewis will generally recommend voting "against" a director who serves as an executive officer of any public company while serving on a total of more than two (instead of three) public company boards (including their own) and any other director who serves on a total of more than five public company boards. However, Glass Lewis has introduced some flexibility in how it will apply this standard:
Glass Lewis clarified its approach to board evaluation, succession planning and refreshment. Generally speaking, Glass Lewis believes a robust board evaluation process–one focused on the assessment and alignment of director skills with company strategy–is more effective than solely relying on age or tenure limits. This discussion appears in a newly captioned section entitled "Board Evaluation and Refreshment" in the U.S. Guidelines and reflects a shift in focus from a similar discussion that previously appeared under the heading "Mandatory Director Term and Age Limits."
Glass Lewis clarified how it approaches corporate governance at newly public entities. While it generally believes that such companies should be allowed adequate time to fully comply with marketplace listing requirements and meet basic governance standards, Glass Lewis will also review the terms of the company’s governing documents in order to determine whether shareholder rights are being severely restricted from the outset. If Glass Lewis believes the board has approved governing documents that significantly restrict the ability of shareholders to effect change, it will consider recommending that shareholders vote "against" members of the governance committee or the directors that served at the time of the governing documents’ adoption, depending on the severity of the concern. The new guidelines outline the specific areas of governance Glass Lewis will review (for example, antitakeover provisions, supermajority vote requirements, and general shareholder rights, such as the ability of shareholders to remove directors and call special meetings).
Glass Lewis codified its policy concerning shareholder proposals requesting that companies provide increased disclosure concerning efforts taken to ensure gender pay equity. Glass Lewis will review these proposals on a case by case basis and will consider (a) the company’s industry; (b) the company’s current policies, efforts and disclosure with regard to gender pay equity; (c) the practices and disclosure of company peers; and (d) any relevant legal and regulatory actions at the company. Glass Lewis will consider recommending votes in favor of "well-crafted shareholder resolutions requesting more disclosure on the issue of gender pay equity in instances where the company has not adequately addressed the issue and there is credible evidence that such inattention presents a risk to the company’s operations and/or shareholders."
The following Gibson Dunn lawyers assisted in the preparation of this client alert: Elizabeth Ising, Lori Zyskowski, Ronald Mueller, Sean Feller, Gillian McPhee and Matt Haskell.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm’s Securities Regulation and Corporate Governance and Executive Compensation and Employee Benefits practice groups, or any of the following:
Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Co-Chair, Washington, D.C. (+1 202-955-8287, [email protected])
James J. Moloney - Co-Chair, Orange County, CA (+1 949-451-4343, [email protected])
Brian J. Lane - Washington, D.C. (+1202-887-3646, [email protected])
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, [email protected])
John F. Olson – Washington, D.C. (+1 202-955-8522, [email protected])
Lori Zyskowski – New York (+1 212-351-2309, [email protected])
Gillian McPhee – Washington, D.C. (+1 202-955-8201, [email protected])
Julia Lapitskaya – New York (+1 212-351-2354, [email protected])
Sarah E. Fortt – Washington, D.C. (+1 202-887-3501, [email protected])
Kasey L. Robinson – Washington, D.C. (+1 202-887-3587, [email protected])
Executive Compensation and Employee Benefits Group:
Stephen W. Fackler – Co-Chair, Palo Alto/New York (+1 650-849-5385/+1 212-351-2392, [email protected])
Michael J. Collins – Co-Chair, Washington, D.C. (+1 202-887-3551, [email protected])
Sean C. Feller – Los Angeles (+1 310-551-8746, [email protected])
© 2016 Gibson, Dunn & Crutcher LLP
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