In November 2018, Institutional Shareholder Services (ISS) released updates to its 2019 U.S. voting policies, which will be effective for meetings on or after February 1, 2019, and a preliminary list of frequently asked questions (FAQs) relating to U.S. compensation policies for 2019. ISS’s announced changes for 2019 relate to board gender diversity, management proposals to ratify existing charter or bylaw provisions, non-employee director compensation, and equity plan provisions, among others. These updates are summarized below.
1. Board Gender Diversity
- Starting in 2018, ISS research reports began noting lack of gender diversity on boards.
- ISS announced a new voting policy on directors for companies with no female directors serving on their boards, with a year’s grace period before implementation. The new policy will be effective for meetings on or after February 1, 2020, and will be applicable for companies in either the Russell 3000 or S&P 1500 indices.
- ISS will generally issue recommendations against the election of the chair of the nominating committee, but on a case-by-case basis, the elections of other directors who are responsible for the board nomination process may be impacted (for example, at companies with no formal nominating committee).
- In extraordinary circumstances, ISS may allow the absence of gender diversity to be temporarily explained or excused. Mitigating factors include:
- A firm commitment, stated in the proxy statement, to appoint at least one female director in the near term;
- The presence of a female on the board at the preceding annual meeting; and
- Other relevant factors, as applicable.
- ISS’s policy reflects the trend that many large institutional investors are indicating that they will vote against or withhold their votes from directors due to lack of gender diversity. For example, BlackRock and State Street Global Advisors have announced policies to promote gender diversity on boards that can result in votes against the reelection of nominating committee members of companies that have not sufficiently addressed gender diversity.
2. Board Attendance
ISS codified its case-by-case approach taken when faced with situations of possible chronic poor attendance by directors. ISS defines “chronic poor attendance” as three or more consecutive years of poor attendance (attending less than 75% of their aggregate board and committee meetings) without reasonable explanation such as medical issues or illness, family emergencies, or missing only one meeting out of three or fewer meetings. The policy approach may also be applied in cases where there is a long-term pattern of absenteeism, such as poor attendance the previous year and three out of the four prior years.
Currently, the policy is generally applied as follows:
- Vote against the director with poor attendance;
- After three years of poor attendance by a director, recommend withhold from the chair of the nominating or governance committee;
- After four years, recommend withhold from the full nominating or governance committee; and
- After five years, recommend withhold from all nominees.
When a director with chronically poor attendance is on the ballot, the recommendations at the chair or committee level will be directed towards the nominating committee for continuing to nominate the director, despite the poor attendance. When the director is not on the ballot, as in the case of a classified board, the recommendations will be directed towards the governance committee for maintaining an overarching corporate governance structure where such a director is not annually accountable to shareholders. Of course, most companies subject to the guidelines will have a combined nominating and corporate governance committee.
3. Management Proposals to Ratify Existing Charter or Bylaw Provisions
ISS has adopted a new policy regarding management ratification proposals of existing corporate governance provisions. The policy explicitly provides for adverse vote recommendations for individual directors, members of the governance committee, or the full board, where boards ask shareholders to ratify existing charter or bylaw provisions, unless these governance provisions align with best practice. This policy is intended to discourage companies from using ratification proposals to exclude shareholder proposals that request more shareholder-friendly governance provisions, which ISS noted significantly increased during the 2018 proxy season. ISS will consider the following factors in its analysis of ratification proposals:
- The presence of a shareholder proposal addressing the same issue on the same ballot;
- The board’s rationale for seeking ratification;
- The actions to be taken by the board should the ratification proposal fail;
- Shareholder engagement regarding the board ratification request;
- The level of impairment to shareholders’ rights caused by the existing provision;
- The history of management and shareholder proposals on the provision at the company’s past meetings;
- Whether the current provision was adopted in response to the shareholder proposal;
- The company’s ownership structure; and
- Previous use of ratification proposals to exclude shareholder proposals.
Failure of a management ratification proposal to receive majority support will trigger a board responsiveness analysis at the following annual meeting similar to the analysis ISS currently performs when a shareholder proposal receives majority support. If the board does not adequately address the failure of a management ratification proposal in ISS’s view, it will recommend against the election of individual directors, committee members or the full board.
4. Binding Shareholder Proposals to Amend Bylaws
ISS did not announce any changes to its existing policy under which it will generally recommend voting against or withholding votes from members of a company’s governance committee on an ongoing basis as long as the company imposes “undue restrictions” on the ability of shareholders to amend the bylaws. The existing ISS policy specifies that these restrictions include, but are not limited to, (1) an outright prohibition on the submission of binding shareholder proposals to amend the bylaws or (2) share ownership or holding period requirements for the submission of these proposals in excess of the very lenient standard set forth in Rule 14a-8 (i.e., $2,000 of shares held for one year).
This policy was first adopted by ISS in advance of the 2017 proxy season and is of potential significance to REITs and other companies organized in states such as Maryland that permit restrictions on shareholders’ abilities to amend the bylaws. For additional discussion regarding this adoption of this policy, please refer to Goodwin’s November 21, 2016 and November 2, 2016 client alerts. Since the adoption of this policy, a number of companies following significant shareholder outreach voluntarily modified their bylaw amendment provisions to permit shareholders to submit binding proposals to amend the bylaws if they meet share ownership and holding period requirements stricter than Rule 14a-8 requirements but similar to or less strict than the typical proxy access requirements (i.e., 3% for three years; groups of no more than 20). Notwithstanding these developments, it appears that ISS will continue to apply its existing policy without modification in 2019.
5. Environmental and Social Proposals
ISS has codified existing factors that it takes into consideration when analyzing Environmental and Social (E&S) shareholder proposals. As part of the 2019 updates to ISS’s policy regarding E&S proposals, ISS clarified it will examine primarily whether implementation of the E&S proposal is likely to enhance or protect shareholder value. Furthermore, and importantly, in addition to the six existing factors listed below, ISS has made explicitly clear that it will take into account significant controversies, fines, penalties, or litigation associated with a company’s environmental or social practices when evaluating shareholder proposals. Currently, ISS considers the following six factors in its analysis of E&S shareholder proposals:
- Whether the issues presented in the proposal are more appropriately or effectively addressed through legislation or government regulation;
- Whether the company has already responded appropriately and sufficiently to the issues raised in the proposal;
- Whether the proposal is unduly burdensome or overly prescriptive;
- The company’s approach for addressing the issues raised by the proposal compared with any industry standard practices;
- If the proposal requests increased disclosure or greater transparency, whether reasonable and sufficient information is currently available to shareholders from either the company or other publicly available sources; and
- If the proposal requests increased disclosure or greater transparency, whether implementation would reveal proprietary or confidential information that could place the company at a competitive disadvantage.
6. Quantitative Pay-for-Performance
ISS previously proposed to add Economic Value Added (EVA) factors to its methodology for screening quantitative pay-for-performance. However, this will not take effect for the 2019 proxy season, but will be reconsidered for 2020. In response to public comment, ISS will continue to use accounting performance (GAAP measures) in the financial performance assessment of its quantitative pay-for-performance screen in 2019. ISS continues to explore the potential of EVA factors to add insight into the company performance analysis. To that end, EVA metrics will be included in ISS research reports for informational purposes on a phased-in basis over the 2019 proxy season. ISS reported that feedback received from investors indicated that investors would like more time to fully understand the EVA methodology and its potential to add insight to pay-for-performance evaluation.
7. Non-Employee Director Compensation
ISS noted that, in light of recent feedback received from policy surveys and investor roundtables, it will revise its methodology for identifying non-employee director compensation outliers and delay issuing possible adverse vote recommendations for excessive non-employee director compensation until 2020. The ISS policy regarding excessive non-employee director compensation that was to become effective in 2019 explicitly provides for adverse vote recommendations for board committee members who are responsible for approving or setting non-employee director compensation when there is a pattern (two or more consecutive years) of “excessive” non-employee director pay without a compelling rationale or other mitigating factors. ISS indicated that the revised methodology for identifying pay outliers will be provided in a comprehensive FAQ to be released in December 2018.
8. Equity Plan Scorecard
ISS also included the following non-exhaustive list of updates to the Equity Plan Scorecard (EPSC) methodology for annual meetings on or after February 1, 2019 in its preliminary FAQs:
- In response to investor concerns regarding potentially highly dilutive equity compensation programs, ISS has introduced a new overriding factor relating to excessive dilution for the S&P 500 and Russell 3000 EPSC models. The new overriding factor, which examines share capital dilution (as opposed to voting power dilution), will be triggered in cases where a company’s equity compensation program is estimated to dilute shareholders’ holdings by more than 20% for the S&P 500 model or 25% for the Russell 3000 model.
- ISS will update the change in control (CIC) vesting factor to provide points based on the quality of disclosure of CIC vesting provisions, rather than based on the actual vesting treatment of awards. Specifically, ISS will award full points for this factor where a company’s equity plan discloses with specificity the CIC vesting treatment for both performance-based and time-based awards. If the plan is silent on the CIC vesting treatment for either type of award, or if the plan provides for merely discretionary vesting for either type of award, ISS will award no points for this factor.
- The passing scores for all U.S. EPSC models will remain the same (55 points for the S&P 500 model and 53 points for the Russell 3000 model). Additionally, consistent with prior years, there will be weighting/point reallocations among some of the individual factors within each EPSC model.
A full description of the announced changes to ISS’s 2019 U.S. voting policies, which includes a blacklined comparison showing the changes made and a description of ISS’s rationale for the various changes, and the preliminary FAQs are available on ISS’s website.