On November 20, 2015, Institutional Shareholder Services Inc. ("ISS") released its updated Canadian proxy voting guidelines for meetings on or after February 1, 2016.1 The updates provide new or updated guidance with respect to voting for equity compensation plans, electing directors with too many board appointments and electing directors of externally managed issuers such as REITs.
Equity Compensation Plans
ISS guidance on equity compensation plans for issuers listed on the Toronto Stock Exchange ("TSX") takes a "case-by-case" approach to votes on equity compensation plans, using a new "scorecard" similar to the one adopted by ISS in the U.S. for the 2015 proxy season.
The proprietary ISS "scorecard" evaluates three "pillars" of equity compensation plans:
- Plan Cost: cost of the plan versus industry peers.
- Plan Features: whether there are change-in-control provisions, financial assistance to plan participants for the exercise or settlement of awards, whether there is public disclosure of the full plan document and whether the plan results in reasonable share dilution.
- Grant Practices: considers the three-year average number of securities issued under the plan annually as a percentage of the average outstanding securities of such issuer, time vesting requirements and clawback provisions, the issuance of performance-based equity to the CEO and post-exercise shareholding requirements.
The scorecard analysis will apply different weighting to the pillars based on whether or not the issuer forms part of the S&P TSX Composite Index.
Rationale: ISS asserts that the new scorecard framework will allow a more holistic assessment of equity compensation plans.
- It may be difficult to know whether a plan will score sufficient points (53 are required) to receive a favorable recommendation. Looking back at the 2015 U.S. proxy season, one U.S. commentator noted that over 85% of equity compensation plans in the S&P 500/Russell 3000 Index group received a favourable recommendation using the scorecard approach, which was slightly higher than in the 2014 proxy season, where the scorecard methodology was not employed.2
- ISS intends on publishing a more fulsome FAQ on the new scorecard approach in December. Stay tuned for an update from us once this FAQ is released.
- The current proposed three pillar weighting for S&P/TSX Composite Index constituents is 40% grant practices, 40% plan costs and 20% plan features. This represents a small variance from the weightings used by ISS in its 2016 U.S. scorecard approach for the S&P 500/Russell 3000 Index constituents.3
- ISS has committed to developing "special case" models which will apply to issuers that have just gone public or issuers emerging from bankruptcy, as certain criteria within the grant practices pillar will not be applicable. No Canadian guidance has yet been given on these models.4
- ISS will generally recommend an
"against" vote where any of the following are present in
equity compensation plans:
- discretionary non-employee director participation;
- plan amendment provisions do not require shareholder approval;
- a history of re-pricing options without shareholder approval;
- the plan is a vehicle for problematic pay practices; or
- any other features that are determined to have a significant negative impact on shareholder interests.
Effective February 2017, ISS will consider a director "overboarded" (sitting on an excessive number of boards) if, in the case of a CEO, the director serves on more than one outside public company board or, in the case of non-CEOs, the director serves on more than four public company boards.
The revised policy will generally recommend a withhold vote for an individual director where:
- the director is overboarded; and
- the director has attended less than 75 percent of his or her respective board and committee meetings within the past year, without a valid reason for the absences.
ISS will include cautionary language in all reports where a director is overboarded even if attendance is good.
Rationale: ISS has relied on a 2014 study which suggests that, on average, Canadian public company directors spend 304 hours per year per board with an even greater time commitment for issuers with market caps of greater than $1 billion.5
- The policy guideline contains a "double trigger" requiring the director to be both overboarded and have a poor attendance record within the past year before a withhold vote recommendation will be made.
- Cautionary language included in ISS reports with respect to overboarded directors could influence the level of support in director re-elections.
- The policy is not triggered by a director's commitments on the boards of private companies, not-for-profits or charities nor does it measure substantive contributions in any way other than attendance.
The new guidance takes a "case-by-case" approach with respect to votes on (i) say-on-pay resolutions, and (ii) board elections, when an issuer is externally-managed and where minimal disclosure is provided with respect to any management services agreement and senior management compensation. We expect this guidance to be most relevant for Canadian REITs, mortgage investment corporations and royalty trusts.
ISS recommends, among other things, assessing the following in preparation for any vote:
- the scope of the management services agreement;
- executive compensation in comparison to issuer peers and/or similarly structured issuers;
- overall issuer performance;
- related party transactions;
- board and committee independence;
- conflicts of interest and systems for managing conflicts effectively;
- disclosure and independence of the decision-making process involved in the selection of the management services provider;
- risk-mitigating factors included within the management services agreement;
- historical compensation concerns; and
- executive responsibilities.
Rationale: ISS says executives at externally-managed issuers are often employed by the outside manager which raises conflict of interest issues and that disclosure with respect to management service agreements is insufficient in many cases.
1. Institutional Shareholder Services, Americas Proxy Voting Guidelines Updates: 2016 Benchmark Policy Recommendations (November 20, 2015), available at http://www.issgovernance.com/file/policy/2016-americas-policy-updates.pdf.
3. The weightings for ISS' 2016 U.S. scorecard approach for the S&P 500/Russell 3000 Index group is 45% plan costs and 35% grant practices. The weightings for ISS' 2016 U.S. scorecard approach for Non-Russell 3000 Issuers is 25% grant practices, 45% plan costs and 30% plan features.
4. The weightings used by ISS in its 2015 U.S. scorecard approach for special cases was 60% plan costs and 40% plan features; however, in its recently updated 2016 U.S. scorecard FAQ, ISS has adjusted the weighting percentages and bifurcated the "special case" category into two: Russell 3000 and non-Russell 3000 indexes. The Russell 3000 category will now include a score for grant practices to be weighted at 15%.
5. Institutional Shareholder Services, Director Overboarding (Canada), available at: https://www.issgovernance.com/file/policy/canada-overboarding.pdf
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