Institutional Shareholder Services (“ISS”) published its proxy voting guidelines updates for 2021 (“Policy Updates”) on November 12, 2020. The changes that are likely to be of most interest to companies include new and updated voting recommendations on federal forum and exclusive forum provisions in companies’ governing documents and the racial and ethnic diversity of directors. Companies that are included in the S&P 500 index should be aware that ISS will no longer provide drafts of its reports for review by these companies prior to publication. The Policy Updates will generally be effective for meetings on or after February 1, 2021. The updated policy on racial and ethnic board diversity will be effective for 2022 meetings, as described below.
What Companies Should Consider Now
In light of the Policy Updates, companies that have not yet adopted a Federal Forum Provision (as defined below) may want to consider doing so, and companies that previously adopted a Federal Forum Provision or an exclusive state law bylaw provision should consider whether any amendments should be made to their existing provisions to avoid negative recommendations by ISS. In addition, companies may want to consider adding disclosure to their proxy statements regarding the racial and ethnic diversity of board members. To the extent that the diversity of the board falls short of ISS policy guidelines, which will apply for 2022 meetings, or state laws such as California Assembly Bill 979, which will apply to certain companies at the end of 2021, companies should consider beginning or accelerating recruitment efforts to attract qualified racially or ethnically diverse members.
Federal Forum and Exclusive State Law Forum Bylaws Provisions
As previously discussed in our March 2020 client alert, the Delaware Supreme Court issued a decision in Salzberg v. Sciabacucchi, No. 346, 2019 (Del. Sup. Ct. March 18, 2020), upholding the validity of charter provisions or bylaws that require claims under the Securities Act of 1933 (the “1933 Act”) to be brought in federal court (“Federal Forum Provisions”). Many corporations adopted Federal Forum Provisions in reaction to the United States Supreme Court’s decision in Cyan, Inc. v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018), holding that class actions under the 1933 Act could be brought in either state or federal court and, if filed in state court, could not be removed to federal court. Following a significant increase in parallel state and federal securities class actions after Cyan, and in light of the subsequent Delaware Supreme Court’s Salzberg decision, even more corporations are implementing and enforcing Federal Forum Provisions.
In its Policy Updates, ISS stated that these developments “necessitated a new ISS policy” for Federal Forum Provisions — which ISS noted have been implemented in the form of a bylaw amendment (which can be accomplished unilaterally by the board) or a charter amendment (which requires shareholder approval) — and “provided an opportunity to re-examine the existing policy on exclusive forum provisions for state law matters.”
Recognizing that many Federal Forum Provisions “generally require only that federal securities litigation be brought in the district courts of the United States,” ISS determined that there was no argument that such provisions would “seriously inconvenience plaintiffs,” and that the “benefits of eliminating duplicative litigation and ensuring that cases are heard by courts that are well-versed in the applicable law carry greater weight.” Thus, under its new policy, ISS will generally recommend a vote for federal forum selection in the charter or bylaws that specify the district courts of the United States as the exclusive forum for federal securities law matters and recommend a vote against provisions that restrict the forum to a particular federal district court.
With respect to exclusive forum provisions for state law matters, ISS updated its existing policy of recommending votes using a case-by-case approach. ISS observed that “the likelihood of a speedy and efficient resolution of Delaware corporate law cases ... is considered to be greater if they are heard in Delaware courts.” Thus, ISS stated that it will generally recommend in favor of charter or bylaw provisions designating courts in Delaware as the exclusive forum for corporate law matters for companies incorporated in that state in the absence of serious concerns about corporate governance or board responsiveness to shareholders. ISS retained its case-by-case approach for states other than Delaware and provided that it will generally vote against provisions specifying a particular local court within the state of incorporation or a state other than the state of incorporation.
Importantly, companies should note that ISS will treat a company’s adoption, without a shareholder vote, of a Federal Forum Provision that restricts the forum to a particular federal district court or an exclusive state law forum provision that specifies a particular local court within the state or a state other than the state of incorporation as a “one-time failure” of its unilateral bylaw/charter amendment policy, which will result in an ISS voting recommendation against the re-election of one or more directors deemed responsible.
Gender and ethnic diversity, and the lack thereof, at the board of directors level has been a hot corporate governance topic in the United States in 2020, as highlighted in two recent alerts (New California Law Will Require Increased Diversity on Public Boards (October 14, 2020) and Talking The Talk Versus Walking The Walk: Shareholder Suits Aim to Push Board Diversity and Punish Companies Supposedly Failing to Make Meaningful Change (November 10, 2020)). In response to investors’ focus on gender diversity, ISS previously adopted a policy to recommend voting against the re-election of the chair of the nominating committee (or other directors on a case-by-case basis) at Russell 3000 or S&P 1500 companies where there are no women on the board. ISS has now adopted a similar policy for companies whose boards show an apparent lack of members who are racially or ethnically diverse. This policy is scheduled to go into effect beginning in 2022. In particular:
- For 2021, with regard to companies in the Russell 3000 or S&P 1500, ISS benchmark research reports will highlight any board that lacks racial and ethnic diversity or lacks disclosure of racial and ethnic diversity on the board. The stated purpose of the policy is to foster dialog between investors and these companies on diversity issues. For 2021, ISS will not use lack of racial or ethnic diversity as a factor in its voting recommendations.
- For meetings held on or after February 1, 2022, ISS will commence making voting recommendations under its new policy. Specifically, for any company in the Russell 3000 or S&P 1500 that has a board with no apparent racially or ethnically diverse members, ISS will recommend voting against the re-election of the chair of the nominating committee and, possibly, other directors on a case-by-case basis. ISS will not consider aggregate diversity statistics provided by a company unless they are specific as to racial and/or ethnic diversity. ISS’s new voting policy recognizes one exception: if there was racial and/or ethnic diversity on the board at the preceding annual meeting and the board makes a firm commitment to appoint within one year at least one member who is ethnically or racially diverse.
By delaying the voting recommendations for one year, but providing greater attention to the issue in its research reports, ISS is increasing the pressure on companies to diversify the boardroom while also giving them some time to adequately identify and recruit appropriate talent.
ISS made a number of other changes to its voting policies in the Policy Updates, including:
Board Refreshment (Age/Term Limits) ISS changed its policy regarding management or shareholder proposals for director term/tenure limits. Previously, ISS’s policy was to recommend against these proposals, but scrutinize boards with average tenure in excess of 15 years. Under ISS’s updated policy, it may recommend in favor of some of these proposals. ISS will make voting recommendations on these proposals a case-by-case basis considering various factors, which for a shareholder proposal include the scope of the proposal and evidence of problematic issues at the company combined with, or exacerbated by, a lack of board refreshment.
ISS will continue to oppose mandatory retirement ages for directors. ISS retained its existing policy of recommending voting against proposals for mandatory retirement ages for directors and expanded this policy to also cover recommendations to vote for proposals to remove mandatory age limits.
Risk Oversight Relating to Environmental and Social Issues ISS has updated its policy relating to director elections to list “demonstrably poor risk oversight of environmental and social issues, including climate change” as an example of a material failure in risk oversight that could, under extraordinary circumstances, result in an adverse recommendation by ISS against the re-election of directors.
Independent Director Classification ISS made changes that are generally clarifying and non-substantive to the policy pursuant to which it classifies directors as either executive directors, non-independent non-executive directors or independent directors. Particularly, ISS made explicit a prior policy under which a director with pay comparable to a named executive officer for multiple years will be considered non-independent and clarified that the manager/advisor of an externally managed company will be considered an affiliate, such that directors who are officers or employees of the manager/advisor will not be considered independent.
Poison Pills ISS updated its policy regarding poison pills to clarify that it will recommend voting against the re-election of all board members if the company has a long-term or short-term poison pill with a “dead-hand” or “slow-hand” feature. ISS made this change due many companies’ adoption of a short-term poison pill in response to Covid-19 market volatility, including a few companies’ adoption of a poison pill that included dead-hand or slow-hand provisions. ISS indicated that the adoption of a poison pill with dead-hand or slow-hand features may result in adverse voting recommendations even if the poison pill has expired by the time of the meeting.
Advance Notice Provisions ISS changed its voting policy relating to advance notice provisions (i.e., provisions requiring shareholders to provide advanced notice to the company in order to submit a proposal or nominate a director at an annual meeting of shareholders, other than a shareholder proposal submitted pursuant to Rule 14a-8). ISS’s policy continues to be to make recommendations on a case-by-case basis based, in part, on the reasonableness of the advanced notice deadlines. However, ISS expanded its view of which deadlines will be viewed as reasonable. Previously, ISS only viewed a deadline as reasonable if it was not more than 60 days prior to the meeting. Following the Policy Updates, ISS will view a deadline as reasonable if it is no earlier than 120 days prior to the anniversary of the previous year’s meeting. Because these advance notice provisions are typically contained in companies’ bylaws, they typically are not the subject of proposals that are submitted to shareholders by companies. Nevertheless, the change in ISS’s voting policy is a helpful acknowledgement of the reasonableness of these bylaw provisions.
Virtual Meetings ISS adopted a new voting policy to address proposals relating to virtual shareholder meetings. Because most companies do not need to submit proposals relating to virtual meetings to shareholders, the new policy is unlikely to directly impact most companies. Under the new policy, ISS generally will recommend voting for management proposals allowing for virtual-only shareholder meetings, so long as they do not preclude in-person meetings. ISS’s policy states that companies are encouraged to provide shareholders with comparable rights and opportunities to participate in a virtual-only meeting as they would have at an in-person meeting, but it does not mandate any particular procedures that ISS believes must be followed. ISS’s policy for shareholder proposals relating to virtual-only meetings is to make recommendations on a case-by-case basis considering the scope and rationale of the proposal and any concerns identified with the company’s prior meeting practices.
Other Changes Other updates to ISS’s voting policies related to shareholder proposals for reports on pay data by gender or race/ethnicity, the use of mandatory arbitration for employment-related claims or actions or risks relating to workplace sexual harassment.
ISS Ends Review of Draft Proxy Reports by S&P 500 Companies
Separately from its Policy Updates, ISS recently announced that it will no longer provide U.S.-based S&P 500 companies with an opportunity to review the draft version of the proxy report prepared by ISS. In its November 2, 2020 announcement, ISS provided a number of reasons for this change. These include (1) increased investment by ISS in systems that should result in “a higher degree of factual accuracy” in its reports, making company review “no longer necessary”; (2) the time required to administer the review process; and (3) the preferences and concerns of institutional investors about timing, content and company lobbying of ISS after receiving draft reports.
It is also likely that changes in SEC proxy rules earlier this year were a significant factor in the ISS decision. As described in an earlier client alert (SEC Adopts Final Rules Addressing Proxy Advisory Firms (July 31, 2020)), these amendments expanded the definition of “solicitation” under SEC proxy rules to specifically include proxy voting advice of the type typically provided by ISS and other proxy advisory firms. The amendments also imposed new requirements that proxy advisory firms must meet to avoid subjecting their proxy voting advice to the filing and certain other requirements of SEC proxy rules.
Among these requirements, the amendments require proxy advisory firms to adopt written policies and procedures that are reasonably designed to provide a company with a copy of its proxy voting advice, at no charge, no later than the time such advice is disseminated to the proxy voting advisory service’s clients. The final amendments did not require proxy advisory firms to give companies an opportunity to review and respond to the proxy voting advice before the proxy advisor issues its report to its clients, which the proposed version of the amendments would have required.
A full description of the 2021 updates to ISS’s proxy voting guidelines, which includes a blacklined comparison showing the changes made and a description of ISS’s rationale for the changes, is available on ISS’s website.
Daniel P. AdamsPartner
Deborah S. BirnbachPartnerCo-Chair, Complex Litigation & Dispute Resolution
Caroline H. BullerjahnPartner
Lynda T. GalliganPartnerCo-Chair, Business Law Department
Gregg L. KatzPartner