On November 20, 2015, Institutional Shareholder Services (ISS) released its 2016 Americas Proxy Voting Guidelines Updates (the Guidelines) for meetings held in 2016. The Guidelines are a product of ISS' 2015 global policy survey, which solicited the views of investors, companies, and other interested parties with respect to corporate governance issues. Among the topics considered are director overboarding, proxy access, compensation programs and compensation disclosure at externally-managed issuers. As noted below, ISS intends to provide additional information in a "Frequently Asked Questions" document that will be released in December.
Companies subject to ISS' Canadian policy need to be aware of the following changes:
- Equity Plan Scorecard for equity compensation plans
– TSX companies:
- ISS will evaluate equity plan proposals using three categories of factors: plan cost, plan features, and grant practices;
- Equity compensation plans for S&P/TSX and Non-Composite TSX-listed companies will be evaluated using separate models;
- ISS' vote recommendation will be based upon the overall construction of the plan and historic use of equity, not a series of pass/fail tests; and
- There will still be a small number of negative factors that will prevent ISS support.
- Director overboarding – TSX
- As of February 1, 2017, ISS will issue a negative vote recommendation for directors who are not public company CEOs who sit on more than four public company boards and attend fewer than 75% of meetings without valid reason; and
- ISS will also impose tighter restrictions on the number of boards that sitting public company CEOs may sit on. ISS will issue a negative vote recommendation for overboarding only for public company CEOs who sit on more than one board in addition to their own board and attend fewer than 75% of meetings without valid reason.
- Compensation-related votes at externally-managed
issuers – TSX and TSXV companies:
- ISS will generally recommend against say-on-pay proposals where there is an external management structure in place, and there is insufficient detail in the company's disclosures for ISS to perform a comprehensive pay-for-performance analysis.
Equity Compensation Plans for TSX-listed Companies
The Current Landscape
Currently, ISS' Canadian equity plan policy involves a series of standalone pass/fail tests. In other words, ISS currently (prior to these changes) votes against a plan if certain factors apply: e.g. the total cost of the company's equity plan is unreasonable; the dilution and burn rate are unreasonable; certain plan provisions are not included; or the plan is a vehicle for problematic pay practices.
As a consequence of the Guidelines, the existing pass/fail tests will be replaced with the Equity Plan Scorecard (the EPSC), a concept that was implemented in the U.S. for the 2015 proxy season and which provides for a more holistic analysis of the plan's strengths and weaknesses. The EPSC will involve separate scorecards for companies included in the S&P/TSX Composite Index and non-Composite TSX-listed issuers.
The EPSC will consider a range of positive and negative factors in evaluating equity incentive plan proposals. Specifically, certain features and practices involving three pillars – plan cost, plan features, and grant practices – will be assessed in combination, with positively-assessed factors potentially counterbalancing negatively-assessed factors:
- Plan cost will consider the total estimated cost of the company's equity plans relative to peers, measured by the company's shareholder value transfer in relation to peers.
- Plan features will include the importance of change in control (CIC) provisions, including the absence of single-trigger acceleration of award vesting on a CIC, and the absence of the settlement of performance-based equity at target or above in the event of a CIC acceleration of vesting regardless of performance.
- Grant practices will focus the average burn rate relative to market best practices, time and performance based requirements for CEO equity grants, the implementation of a clawback provision in equity awards, and certain shareholding requirements. ISS will vote against a plan proposal if the combination of the above factors, as determined by an overall score, indicates that the plan is not in shareholders' interest.
Generally, a company's total EPSC will determine whether a "for" or "against" recommendation is warranted. Although details surrounding the EPSC in Canada have not yet been released, in the U.S. a score of 53 or higher (out of a possible 100 points) generally results in a positive recommendation for a proposal.
Importantly, ISS will continue to vote against plans that have certain features, irrespective of any countervailing factors. These disqualifying features include:
- discretionary or insufficiently limited non-employee director participation;
- amendment provisions that permit broad amendment powers without shareholder approval; and
- a history of re-pricing stock options without shareholder approval.
ISS will also vote against a plan if:
- it is a vehicle for "problematic pay practices";
- there is a "significant pay-for-performance disconnect"; or
- there are any other plan features that have a "significant negative impact" on shareholder interests.
More information about this policy and weightings will be included in ISS' EPSC FAQ, which as noted above, is expected to be released in December 2015. For a preview of what this document may look like, readers are invited to consult the 2016 U.S. Equity Plan Scorecard FAQ.
What this Means for Canadian TSX-listed Companies
The new rules will be applied beginning in the 2016 proxy season. Canadian public companies wishing to amend or adopt their equity-based compensation plans will be affected by the Guidelines. It is expected that the new EPSC will provide more balanced voting recommendations and a holistic approach, rather than a strict pass/fail test. For example, the new approach may result in a plan which has a cost that is nominally higher than a company's allowable cap receiving a favourable recommendation if sufficient positive factors are present. Under the previous guidelines, the plan would have received an unfavourable recommendation. The EPSC will incorporate key goals including considering a range of factors, both positive and negative, in determining vote recommendations, and selecting factors based on institutional investors' concerns and preferences and on best practices within the Canadian market established through regulation, disclosure requirements, and best practice principles. It is designed to allow shareholders greater insight into a company's compensation practices.
The Current Landscape
Currently, ISS will generally withhold its vote for an individual director if such a director is overboarded and such director has attended less than 75% of his/her respective board and committee meetings held within the past year without a valid reason for these absences. "Overboard" currently means a CEO of a public company who sits on more than two outside public company boards in addition to the company of which he/she is CEO or a director who is not a CEO of a public company and who sits on more than six public company boards in total.
Effective February 1, 2017, ISS will withhold a vote for individual director nominees if the director is "overboarded" and has attended less than 75% of his/her respective board and committee meetings held within the past year without a valid reason for these absences. The definition of "overboard" will change to mean:
- a CEO of a public company who sits on more than one outside public company board in addition to the company of which he/she is CEO, or
- a non-CEO who sits on more than four public company boards in total.
What this Means for Canadian TSX-listed Companies
The overboarding guidelines will have a one-year grace period and will not be implemented by ISS until February 2017. For 2016, ISS would include cautionary language in their research reports but will not issue a negative vote recommendation solely because a director is overboarded under the revised policy. It is noteworthy that Canada's policy will differ from the U.S. policy: in the U.S., ISS will allow non-CEO directors to sit on up to five public company boards. The difference is likely intended to reflect the number of Canadian public companies.
It is expected that the overall impact of the overboarding policies will be moderate because the ISS policy towards "overboarding" in Canada is double-triggered, that is ISS will vote against recommendation of a director only if the director is both overboarded and has a history of poor attendance at board meetings. Even so, cautionary language will be included in ISS reports if directors are overboarded, regardless of attendance. Overboarded directors will have to ensure attendance at meetings and that accurate records of their attendance are kept.
These limits would decrease the number of public company boards a director can sit on and should increase the pool of qualified individual directors for Canadian public companies generally.
The Current Landscape
Currently, compensation disclosure regarding the management services agreement and how senior management at externally-managed issuers (EMIs) is compensated is usually limited to the aggregate management/incentive fees paid to such management company. ISS does not currently have a general recommendation regarding EMIs.
The Guidelines provide that, where there is an external management structure in place and there is insufficient detail in the company's disclosure materials for ISS to perform comprehensive pay-for-performance analysis, ISS will issue negative recommendations on say-on-pay proposals (where provided) and on the election of individual directors, committee members or the entire board. Where an EMI does not have a say-on-pay proposal (these remain voluntary in Canada), factors other than disclosure should also be considered.
Additional factors that will be considered may include, but are not limited to, size and scope of the management services agreement, executive compensation in comparison to issuer peers and/or similarly structured issuers, overall performance, related party transactions, conflicts of interest and board and committee independence, decision making process, risk management, historical compensation concerns, executives' responsibilities, and other factors that may reasonably be deemed appropriate to asses an EMI's governance framework.
What this Means for Canadian TSX and TSX-V listed Companies
Because say-on-pay votes are voluntary in Canada, the effect of this policy will more likely be seen in recommendations on the election of directors and will be very relevant to EMIs in the mining sector. All non-controlled TSX-listed issuers are required to adopt majority voting director resignation policies which could result in a director being required to resign from a board if he or she receives more "withhold" than "for" votes at the shareholders' meeting.
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.