Canada: ISS Announces Key 2014 Draft Policy Updates

On October 21, 2013, Institutional Shareholder Services (ISS), an influential proxy advisory firm, released three proposed updates to its Canadian proxy voting guidelines. The proposed updates relate to director overboarding, pay for performance quantitative screen and problematic audit-related issues. ISS is seeking feedback from market participants to finalize these updated guidelines, which will be published in November 2013 and will apply to shareholder meetings of publicly traded Canadian companies occurring on or after February 1, 2014.

ISS recommendations can have a significant impact on the outcome of business conducted at shareholder meetings, especially if institutional investors comprise a significant component of the shareholder base. Although the impact of the proposed updates is expected to be minimal in the 2014 proxy season, Canadian public companies should review the proposed updates with their legal counsel to determine the likely impact and take steps to mitigate any potential adverse voting recommendations from ISS.

Director Overboarding

"ISS proposes to vote against director nominees who are overboarded and have low attendance at meetings."

Directors are considered to be overboarded under ISS' voting guidelines if the director: (i) is a CEO of a public company and sits on more than two outside public company boards in addition to the company of which he/she is CEO; or (ii) is not CEO and sits on more than six public company boards in total.

Under the current ISS voting guidelines, ISS will include a cautionary statement regarding the number of additional public company board seats held by directors if a director is overboarded, but ISS will not make a voting recommendation relating thereto. ISS will also currently recommend a withhold vote from an individual director nominee only if: (i) the company has not adopted a majority voting policy and the nominee director has attended less than 75 percent of board and committee meetings held within the past year without a valid reason for these absences; or (ii) the company has adopted a majority voting policy and the nominee director has attended less than 75 percent of board and committee meetings held within the past year without a valid reason for these absences and a pattern of low attendance exists based on meeting attendance in prior years.

Under the proposed update, ISS would recommend a withhold vote from a nominee director, whether or not a company has adopted a majority voting policy, if a director is overboarded and has, without a valid reason, attended less than 75 percent of his/her respective board and committee meetings held within the past year. Notwithstanding the foregoing, ISS would not recommend a withhold vote for the election of an overboarded CEO to the board of the company that he/she is the CEO of.

Adoption of the proposed update would more closely align ISS' Canadian voting guidelines with those in the U.S., which recommends shareholders vote against overboarded directors; however, they would still differ as under the proposed update: (i) TSX Venture Exchange companies are excluded from its application; and (ii) a withhold vote recommendation requires, in addition to the director being overboarded, that the director does not attend meetings, which additional factor is due to feedback received by ISS from Canadian investors that director overboarding, without other governance concerns (such as low meeting attendance), is not sufficient to merit sanction.

Pay for Performance Quantitative Screen

"ISS proposes to measure TSR and CEO's pay rankings over a three-year period only and no longer consider an additional one-year period."

ISS evaluates the alignment of the CEO's total compensation with company performance over time. If ISS determines there is significant long-term misalignment, ISS will generally recommend voting against management say-on-pay proposals, against/withhold compensation committee members (or, in rare cases where the full board is deemed responsible, all directors including the CEO), and/or against equity-based incentive plan proposals.

The proposed update would simplify ISS' methodology for calculating the relative degree of alignment (RDA), which forms part of ISS' long-term alignment analysis. The RDA is currently calculated as the difference between the company's total shareholder return (TSR) rank and the CEO's total pay rank within a peer group, as measured over both one‐year and three‐year periods (weighted 40 percent and 60 percent, respectively). Under the proposed update, ISS would simply calculate the difference between the company's TSR rank and the CEO's total pay rank within a peer group, as measured over a three‐year period only.

ISS believes that a single three‐year measure provides a better view on long-term pay and performance alignment, mitigates short-term volatility and reduces the effects from the timing of equity awards.

ISS advises that the policy update is not intended to change the number of companies that are identified as potential concerns by the RDA portion of the long-term alignment analysis, and that backtesting indicates that less than seven percent of companies with significant differences between their one‐ and three‐year pay and/or performance will have RDA measures that would be materially affected by this change. However, ISS' policy update will result in reduced RDA rankings for companies characterized by increases in alignment in the most recent year as compared to the prior two years.

Problematic Audit-Related Issues

"ISS proposes to make voting recommendations in respect of nominee directors of companies with adverse accounting practices that give rise to a level of serious concern (e.g., accounting fraud, misapplication of applicable accounting standards or persistent material weakness in the internal control process)."

ISS' current voting guidelines do not address "problematic audit-related issues", which arise when ISS has serious concerns as to a company's audit committee oversight of the implementation of effective internal controls over the accounting process and financial reporting. ISS proposes to update its policy to address those audit related concerns that persist, without remediation by the directors, beyond a reasonable period of time.

The proposed update adopts a case-by-case policy when recommending a vote on nominee directors who are members of an audit committee or, possibly, the full board where adverse accounting practices are identified that give rise to a level of serious concern (e.g., accounting fraud, misapplication of applicable accounting standards or persistent material weakness in the internal control process). Factors that ISS would consider when making a voting recommendation include the severity, breadth, chronological sequence, duration and the company's disclosed efforts to resolve such audit-related issuers.

The proposed policy is quite broad as it does not include definitive parameters to permit companies to predict the likely ISS voting recommendation. As part of the current comment process, ISS is seeking specific comments on the factors that would impact a voting decision, including, for example, the period of time that would be considered reasonable to mitigate concerns.

ISS is seeking comments in respect of each of the proposed updates. The ISS' comment period on the proposed updates closes on November 4, 2013, and Bennett Jones is able to assist clients in submitting their comments on the ISS' proposed updates. The proposed policy updates may be viewed in full at http://www.issgovernance.com/2014draftpolicycommentperiod.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Authors
Karen Keck
Jon C. Truswell
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