Proxy advisory firms Institutional Shareholder Services (ISS) and Glass Lewis (GL) have issued their policy updates for the upcoming 2023 proxy season. In general, ISS’s updates build incrementally on positions the firm has taken in recent years on climate change, diversity, governance structures, and pay practices. GL has adopted new policies in the areas of board demographic diversity and climate change. Both firms have indicated they will review on a case-by-case basis proposed charter amendments relating to exculpation of certain officers by corporations under amended Section 102(b)(7) of the Delaware General Corporation Law (DGCL) and similar provisions adopted under the corporation laws of other states. This alert summarizes the principal changes applicable to US companies for the 2023 proxy season.
In December 2022, ISS announced its 2023 governance policy updates for US-listed companies and those listed in other countries. The ISS policy updates will generally apply to shareholder meetings taking place on or after February 1, 2023. Below is an overview of key 2023 policy changes and clarifications adopted by ISS.
Director and Officer Exculpation. Effective August 1, 2022, Section 102(b)(7) of the DGCL was amended to permit a corporation’s certificate of incorporation to include a provision eliminating or limiting monetary liability for certain senior corporate officers acting in good faith for breaches of the fiduciary duty of care not involving intentional misconduct. Previously, the provision only extended to exculpation of directors. The provision does not permit exculpation for officers for breaches of the duty of loyalty nor does it allow companies to eliminate officers’ monetary liability for breach of fiduciary duty claims brought by the corporation itself or for derivative claims brought by shareholders in the name of the corporation. Despite recommending earlier in 2022 that shareholders vote in favor of charter amendments proposed by several Delaware corporations to implement officer exculpation, ISS’s policy update for 2023 does not include a blanket policy in favor of such amendments but indicates that it will review these proposals on a case-by-case basis considering the extent to which the proposal would:
- Eliminate directors’ and officers’ liability for monetary damages for violating the duty of care
- Eliminate directors’ and officers’ liability for monetary damages for violating the duty of loyalty
- Expand coverage beyond legal expenses to include liability for violations of fiduciary duties that are more serious than acts of mere carelessness
It will be necessary to continue to monitor ISS’s approach as additional proposals are brought forth.
ISS has revised its policy on indemnification provisions to provide for voting on a case-by-case basis on indemnification-related charter amendments or other proposals that expand the scope of indemnification to provide for mandatory indemnification of company officials in connection with acts for which the company was previously merely permitted to provide indemnification at the discretion of the company's board. Previously, ISS’s policy had been to vote against such proposals; however, because this change was not specifically discussed as a substantive change in ISS’s policy updates, it may not represent a change in how ISS will apply its policy to these proposals.
Board Diversity. Last year, ISS indicated that it would generally issue negative voting recommendations on the nominating committee chair (or other directors on a case-by-case basis) of companies in the S&P 1500 Index and the Russell 3000 Index with no female directors, with an exception made if there was at least one woman on the board at the preceding annual meeting and the board makes a firm commitment to return to a gender-diverse status within a year. Beginning for meetings held after February 1, 2023, this policy applies to all companies (not just those in the indices identified above).
Climate Change. Last year, ISS adopted policies applicable to companies in certain identified markets that are on the Climate Action 100 Focus List (166 companies — mostly airlines and companies involved in the chemical, energy, automobile, and very large consumer products industries). Specifically, ISS indicated that it will issue a negative voting recommendation on “responsible incumbent directors,” which will usually mean the relevant committee chair or board chair in the first year, if the company has not taken ISS’s “minimum steps” to understand, assess, and mitigate climate change risks. These minimum steps include detailed disclosure of climate-related risks and appropriate greenhouse gas emissions (GHG) reduction targets.
For 2023, ISS’s policy incorporates a stricter view of what constitutes appropriate GHG emissions reduction targets. In order to satisfy this requirement for 2023, applicable companies are expected to adopt medium-term GHG reduction targets or Net Zero-by-2050 GHG reduction targets for a company’s operations (Scope 1) and electricity use (Scope 2), which should cover the vast majority of direct emissions for most companies.
As a reminder, for companies not in the Climate Action 100 Focus List, ISS has codified its broad case-by-case framework for evaluating climate-related proposals submitted by shareholders or by management. For shareholder proposals requesting “say on climate” votes and other climate-related actions, ISS will analyze each request on a case-by-case basis, taking into account the details of the request and the company’s current climate-related disclosures and performance.
Poison Pills. In evaluating whether to issue a negative voting recommendation on directors who have approved a short-term poison pill without shareholder approval, ISS considers a number of aspects of the adopted pill. For 2023, ISS will expressly take into account the percentage ownership level that triggers the pill. It considers a threshold of five to ten percent to be too low and indicative of an attempt to entrench management and the board rather than to prevent an opportunistic takeover that does not reflect the company’s long-term value.
Dual Class Share Structures. As previewed last year, ISS will issue negative voting recommendations on directors at all companies that employ what ISS calls “unequal voting rights,” removing the previous exception for established companies. Newly-public companies with a sunset provision of no more than seven years from the date of going public will continue to be excepted from this policy during that seven-year period. ISS policies will also continue to provide a de minimis exception for companies where super-voting shares represent five percent or less of total voting power and an exception for unequal voting structures associated with limited partnerships and the operating partnership structure of REITs.
“Problematic Governance Structures” Sunset Period for Newly-Public Companies. ISS has maintained a policy to issue negative voting recommendations on directors if, prior to or in connection with the company’s initial public offering, the company adopted bylaw or charter provisions that ISS considers to be materially adverse to shareholder rights. ISS has generally deemed charter provisions such as supermajority vote requirements to amend the bylaws or charter, a classified board structure and certain other “egregious” provisions as “problematic.” However, it has refrained from issuing negative voting recommendations on directors on the basis of these factors if there is a “reasonable” sunset provision attached to them, which ISS has viewed as a mitigating factor. Effective for 2023, ISS has replaced “reasonable” with a specific seven-year (or shorter) sunset requirement. ISS’s voting policy remains to issue negative voting recommendations on directors at the first annual meeting after the company with a problematic governance structure has gone public and, thereafter, to make recommendations on a case-by-case basis in subsequent years unless the adverse provision is reversed or removed. The seven-year sunset provision applies to all companies holding their first annual shareholder meeting as a public company after February 1, 2015.
Fee-Shifting Provisions. ISS has long had a policy of issuing negative voting recommendations on members of a board that amends a company’s bylaws or charter without shareholder approval in a manner that, in its view, materially diminishes shareholders’ rights or that could adversely impact shareholders, providing a lengthy list of provisions that trigger such a position. For 2023, ISS has added to the list the unilateral adoption of fee-shifting provisions, which are provisions in the charter or bylaws that require a shareholder who sues a company unsuccessfully to pay all litigation expenses of the defendant corporation and its directors and officers.
Quorum Requirements. ISS has changed its previous policy of generally issuing negative voting recommendations on proposals to reduce quorum requirements for shareholder meetings below a majority of the shares outstanding unless there are compelling reasons to support the proposal. ISS will now issue recommendations on these proposals and directors who unilaterally lower quorum requirements on a case-by-case basis. ISS indicated that this policy change was based on the growing number of smaller companies that have needed to adjourn their meetings due to the lack of a quorum, in part, based on the decision by certain large brokerage firms to no longer engage in discretionary voting on behalf of their account holders. ISS’s policy indicates that a quorum threshold as close to a majority of shares outstanding as is achievable is preferred. For larger companies with significant institutional ownership and no demonstrated inability to achieve a quorum, this policy change is unlikely to represent a change in ISS’s position with respect to those companies.
Pay Practices — Severance Payments. In evaluating whether a severance payment represents a problematic pay practice, ISS considers a number of factors, some of which are explicitly set forth in its policies as carrying significant weight. The 2023 updates codify its view that severance payments received by an executive when the termination is not clearly disclosed as involuntary will be characterized as a problematic pay practice carrying significant weight that “may” result in adverse vote recommendations on say-on-pay votes or, in the absence of such a vote or in egregious situations, on members of the compensation committee and potentially the full board. ISS also clarifies that the list of problematic pay practices identified in the policy is not an exhaustive list of practices that may result in adverse voting recommendations.
Share Issuances by US Domestic Issuers Incorporated Abroad. Companies incorporated in certain markets are required by the laws of the country of incorporation to seek shareholder approval for all new share issuances. ISS has adopted a new policy for share issuance proposals submitted in compliance with such laws by companies that are incorporated in a jurisdiction outside the US and that are listed solely on a US stock exchange.
Under the policy, ISS will generally issue a positive voting recommendation on resolutions to authorize the issuance of common shares up to 20 percent of currently-issued common share capital, if the issuance is not tied to a specific transaction or financing. For pre-revenue or other early-stage companies that are heavily reliant on periodic equity financing, ISS will generally issue a positive voting recommendation on resolutions to authorize the issuance of common shares up to 50 percent of currently-issued common share capital. The burden of proof will be on the company to establish that it has a need for the higher limit.
ISS will continue to evaluate proposals by companies that are listed on both a US stock exchange and a foreign stock exchange under the ISS policy that applies to the market in which the company is incorporated. ISS will also continue to evaluate proposals that involve a specific transaction or financing on a case-by-case basis.
Equity Plans — Burn Rate Analysis. In evaluating whether to issue a positive voting recommendation on new or amended equity compensation plans, ISS utilizes an “Equity Plan Scorecard” that considers a number of factors, including the company’s three-year burn rate relative to its peers. As announced last year, for meetings held on or after February 1, 2023, ISS is shifting to a “value-adjusted” burn rate methodology for this component, which aims to more precisely measure each company’s burn rate by using a Black-Scholes model to value options instead of using a multiplier based on the company’s historical stock volatility.
In November 2022, GL announced the release of its 2023 Policy Guidelines for the United States. For 2023, GL has adopted new policies on overboarding and board diversity. In a number of areas, including director diversity disclosure and board oversight of environmental and social issues, GL has expanded its policies from covering only S&P 500 companies to applying to Russell 1000 Index companies. The new guidelines are effective for meetings occurring after January 1, 2023. Below is an overview of key GL policy changes and clarifications for 2023 shareholder meetings.
Director and Officer Exculpation. Like ISS, during 2022, GL recommended voting in favor of several proposals to amend certificates of incorporation to implement the exculpation of officers under amended Section 102(b)(7) of the DGCL, stating in at least one instance that such an amendment would not have a negative impact on shareholders. In its policy updates for 2023, GL indicated that it will closely evaluate proposals to adopt officer exculpation provisions on a case-by-case basis and expects to generally issue a negative voting recommendation on proposals eliminating monetary liability for breaches of the duty of care for certain corporate officers, unless a compelling rationale for the adoption is provided by the board and the provisions are reasonable. We will continue to monitor what rationales GL deems compelling and what provisions it considers to be reasonable.
Board Diversity. Historically, GL’s board diversity policies focused more on gender diversity among directors rather than demographic or ethnic diversity. In its update for 2023, GL has extended its guidelines to include demographic and ethnic diversity. GL indicates that it will generally issue a negative voting recommendation on the chair of the nominating committee of a board with fewer than one director from an underrepresented community on the board at companies within the Russell 1000 Index. An individual from an “underrepresented community” means someone who self-identifies as Black, African American, North African, Middle Eastern, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaskan Native, or who self-identifies as gay, lesbian, bisexual, or transgender.
GL has extended the scope of its existing policy provisions related to board diversity and other disclosure from S&P 500 companies to Russell 1000 companies. In particular, GL may issue negative voting recommendations on the chair of the nominating and/or governance committee of Russell 1000 companies that fail to adequately present (i) the board’s current percentage of racial/ethnic diversity; (ii) whether the board’s definition of diversity explicitly includes gender and/or race/ethnicity; (iii) whether the board has adopted a policy requiring women and minorities to be included in the initial pool of candidates when selecting new director nominees; and (iv) board skills disclosure. GL will also generally issue a negative voting recommendation on the chair of the nominating and/or governance committee of Russell 1000 companies that have not provided any disclosure of individual or aggregate racial/ethnic board demographic information.
For 2022, GL introduced policies tying its recommendations on director elections to compliance with state laws relating to director gender diversity. In light of decisions by a California trial court that the California law that mandates gender diversity at publicly-traded companies that are headquartered in California violates the California constitution, GL has suspended these policies for 2023.
Overboarding. GL has updated its standards on director overboarding for 2023. It will issue a negative voting recommendation on directors up for election in the following circumstances:
- A director who serves as an executive officer (other than executive chair) of any public company while serving on more than one external public company board
- A director who serves as an executive chair of any public company while serving on more than two external public company boards
- Any other director who serves on more than five public company boards
Board Oversight of Environmental and Social Matters. For 2022 meetings, GL stated that it would generally issue a negative voting recommendation on the nominating and/or governance committee chair of any S&P 500 company that failed to provide explicit disclosure about the role of the board in overseeing environmental and social issues. For 2023, GL has extended that policy to Russell 1000 companies. GL notes that, in evaluating a board’s role in overseeing environmental and social issues, it will examine a company’s proxy statement and governing documents (such as committee charters) to determine if directors maintain a meaningful level of oversight and accountability for a company’s material environmental and social risks.
Climate-Related Issues. GL has announced policy provisions applicable to companies with respect to which GHG emissions represent a financially material risk, such as those companies identified by groups like the Climate Action 100+. GL takes the position that these companies should provide thorough climate-related disclosures in line with the recommendations of the Task Force on Climate-Related Financial Disclosures. GL expects the boards of these companies to have explicit and clearly defined oversight responsibilities for climate-related issues and may issue a negative voting recommendation on responsible directors up for election in instances where it judges relevant disclosures to be absent or significantly lacking.
Long-Term Incentives. Beginning in 2022, GL will cite as a negative factor in its say-on-pay recommendations instances where executive pay programs are designed to have less than 50 percent of an executive’s long-term incentive awards that are subject to performance-based vesting conditions. Previously, the minimum percentage was 33 percent. GL believes that well-structured long-term incentive awards have performance or vesting periods of at least three years.
Front-Loaded Awards and Mega Grants. GL has added to its policy guidelines an extended discussion of front-loaded compensation awards, which are described as large grants, usually in the form of equity awards, that are intended to serve as compensation for multiple years. Such grants may include “mega grants” with an initial value of $100 million or more. GL expresses reservations about the retentive value of such awards, the risk of reducing the flexibility of compensation committees to adjust compensation to reflect changed circumstances and the potential for excessive payouts. GL further expresses a policy preference that it expects any front-loaded awards to include a firm commitment by the company not to grant additional awards for a defined period.
GL will also generally issue a negative voting recommendation on the chair of a compensation committee where certain outsized awards or “mega-grants” have been issued and the awards present concerns such as excessive size, lack of sufficient performance conditions, and/or being excessively dilutive, among others.
Compensation Committee Discretion. While not adopting new policies related to the exercise of discretion by compensation committees with respect to incentive-based compensation, GL has codified its views on the matter. GL policies now indicate that it recognizes the importance of judicious and responsible exercise of discretion over incentive pay outcomes to account for significant events that would otherwise be excluded from performance results of selected metrics of incentive programs. That said, GL has also indicated that it expects companies to provide thorough discussion of how such events were considered in the committee’s decisions to exercise discretion or refrain from applying discretion over incentive pay outcomes.
Sean M. DonahuePartnerChair, Public Company Advisory Practice
Daniel P. AdamsPartner
James H. Hammons Jr.Knowledge Management Lawyer
John O. NewellCounsel