United States: ISS And Glass Lewis Update Their Proxy Voting Guidelines For 2017

Institutional Shareholder Services Inc. ("ISS") and Glass, Lewis & Co., LLC ("Glass Lewis") recently updated the guidelines they will use to inform their voting recommendations for the 2017 proxy season. The updates address topics such as equity plans, director and executive compensation, director overboarding, governance following an IPO, and restrictions on submission of binding shareholder proposals. We summarize the most notable updates to these guidelines below.

ISS

The ISS voting policy updates are relevant to shareholder meetings taking place on or after February 1, 2017.

Restrictions on Binding Shareholder Proposals. In its 2017 guidelines update, ISS adopted a new policy regarding the ability of shareholders to amend the bylaws. ISS will now recommend voting against or withholding votes from members of the governance committee if the company's charter imposes undue restrictions on shareholders' ability to amend the bylaws. Such restrictions include, but are not limited to, outright prohibitions on the submission of binding shareholder proposals, or share ownership requirements or time holding requirements in excess of Exchange Act Rule 14a-8. In adopting this new policy, ISS noted that "[s]hareholders' ability to amend the bylaws is a fundamental right."

Unilateral Bylaw/Charter Amendments and Problematic Capital Structures – IPO Companies.  For newly public companies, ISS will recommend voting against or withholding votes from directors individually, committee members, or the entire board (with new nominees to be considered on a case-by-case basis) if, prior to or in connection with the company's public offering, the company or its board adopted bylaw or charter provisions materially adverse to shareholder rights, or implemented a multi-class capital structure in which the classes have unequal voting rights, considering the following factors:

  • The level of impairment of shareholders' rights;
  • The disclosed rationale;
  • The ability to change the governance structure in the future (e.g., limitations on shareholders' right to amend the bylaws or charter, or supermajority vote requirements to amend the bylaws or charter);
  • The ability of shareholders to hold directors accountable through annual director elections, or whether the company has a classified board structure;
  • Any reasonable sunset provision; and
  • Other relevant factors.

This policy expands upon ISS's previous policy regarding unilateral bylaw/charter amendments by providing for adverse vote recommendations for director nominees if a company completes its public offering with a multi-class capital structure, in which the classes do not have identical voting rights. ISS noted an increase in the number of companies completing initial public offerings with multi-class capital structures.

Overboarded Directors. For 2017 annual meetings, ISS announced that it will recommend a vote against or withhold votes from individual directors who sit on more than six public company boards. For CEOs of public companies who sit on the boards of more than two public companies beside their own, ISS will recommend withholding a vote for such individual only at their outside boards. 

Although all of a CEO's subsidiary boards will be counted as separate boards for purposes of the policy, ISS will not recommend a withhold vote for the CEO of a parent company board, or any of the controlled (>50 percent ownership) subsidiaries of that parent, but may do so at subsidiaries that are less than 50 percent controlled and boards outside the parent/subsidiary relationships.

ISS's new voting policy for overboarded directors ends a previously announced one-year transition period. 

Stock Distributions: Splits and Dividends. Previously, ISS recommended a vote for management proposals to increase the common share authorization for a stock split or share dividend, provided that the increase in authorized shares is equal to or less than the allowable increase calculated in accordance with ISS's Common Stock Authorization policy. For 2017 annual meetings, ISS modified its policy from "increase in authorized shares" to "effective increase in authorized shares," to clarify the policy with respect to forward stock splits and stock dividends because proposals to increase authorized common shares may be tied to the implementation of a planned stock split or stock dividend.

Equity and Incentive Compensation Plans. For 2017 annual meetings, ISS will recommend a vote on a case-by-case basis on certain equity-based compensation plans depending on a combination of certain plan features and equity grant practices, where positive factors may counterbalance negative factors, and vice versa, as evaluated using an "equity plan scorecard" (EPSC) approach with three pillars:

  • Plan Cost: The total estimated cost of the company's equity plans relative to industry/market cap peers, measured by the company's estimated Shareholder Value Transfer (SVT) in relation to peers and considering both (i) SVT based on new shares requested plus shares remaining for future grants, plus outstanding unvested/unexercised grants; and (ii) SVT based only on new shares requested plus shares remaining for future grants.

  • Plan Features: Taking into account factors such as automatic single-triggered award vesting upon a change-of-control; discretionary vesting authority; liberal share recycling on various award types; lack of minimum vesting period for grants made upon the plan; and/or dividends payable prior to award vesting.

  • Grant Practices: Taking into account the following:
    • The company's three-year burn rate relative to its industry/market cap peers;
    • Vesting requirements in most recent CEO equity grants (three-year look-back);
    • The estimated duration of the plan (based on the sum of shares remaining available and the new shares requested, divided by the average annual shares granted in the prior three years);
    • The proportion of the CEO's most recent equity grants/awards subject to performance conditions;
    • Whether the company maintains a clawback policy; and/or
    • Whether the company has established post-exercise/vesting shareholding requirements.

ISS will generally recommend a vote against the plan proposal if the combination of above factors indicates that the plan is not, overall, in shareholders' interests, or if any of the following egregious factors apply:

  • Awards may vest in connection with a liberal change-of-control definition;
  • The plan would permit repricing or cash buyout of underwater options without shareholder approval (either by expressly permitting it—for NYSE- and Nasdaq-listed companies—or by not prohibiting it when the company has a history of repricing, for non-listed companies);
  • The plan is a vehicle for problematic pay practices or a significant pay-for-performance disconnect under certain circumstances; or
  • Any other plan features are determined to have a significant negative impact on shareholder interests.

ISS's proxy voting policy for this topic for 2017 annual meetings was updated to add dividends payable prior to vesting as a plan feature. ISS noted in its updated guidelines that "full points will be earned if the equity plan expressly prohibits, for all award types, the payment of dividends before the vesting of the underlying award;" however, accrual of dividends payable upon vesting is acceptable. A company's general practice of not paying dividends until vesting will not suffice.

Cash and Equity Plan Amendments. For 2017 annual meetings, ISS clarified its approach for evaluating the different types of proposals involving amendments to cash and equity incentive plans. ISS will recommend a vote on a case-by-case basis on amendments to cash and equity incentive plans, with specific voting recommendations for distinct proposals detailed below.

ISS will generally recommend a vote for proposals to amend executive cash, stock, or cash and stock incentive plans if the proposal:

  • Addresses administrative features only; or
  • Seeks approval for Section 162(m) purposes only, and the plan administering committee consists entirely of independent outside directors, per ISS's Categorization of Directors. Note that if the company is presenting the plan to shareholders for the first time after the company's IPO, or if the proposal is bundled with other material plan amendments, then the recommendation will be case-by-case (see below).

ISS will recommend a vote against proposals to amend executive cash, stock, or cash and stock incentive plans if the proposal seeks approval for Section 162(m) purposes only, and the plan administering committee does not consist entirely of independent outside directors, per ISS's Categorization of Directors.

ISS will recommend a vote on a case-by-case basis on all other proposals to amend cash incentive plans. This includes plans presented to shareholders for the first time after the company's IPO and/or proposals that bundle material amendment(s) other than those for Section 162(m) purposes.

ISS will recommend a vote on a case-by-case basis on all other proposals to amend equity incentive plans, considering the following:

  • If the proposal requests additional shares and/or the amendments may potentially increase the transfer of shareholder value to employees, the recommendation will be based on the Equity Plan Scorecard evaluation as well as an analysis of the overall impact of the amendments;
  • If the plan is being presented to shareholders for the first time after the company's IPO, whether or not additional shares are being requested, the recommendation will be based on the Equity Plan Scorecard evaluation as well as an analysis of the overall impact of any amendments; and/or
  • If there is no request for additional shares and the amendments are not deemed to potentially increase the transfer of shareholder value to employees, then the recommendation will be based entirely on an analysis of the overall impact of the amendments, and the EPSC evaluation will be shown for informational purposes.

Management Proposals to Ratify Director Compensation. Citing a number of recent high-profile lawsuits regarding excessive non-employee director compensation, ISS created a new voting policy with respect to ratification of director pay programs. For 2017 annual meetings, ISS will recommend a vote on a case-by-case basis on management proposals seeking ratification of non-employee director compensation, based on the following factors:

  • If the equity plan under which non-employee director grants are made is on the ballot, whether or not it warrants support; and
  • An assessment of the following qualitative factors:
    • The relative magnitude of director compensation as compared to companies of a similar profile;
    • The presence of problematic pay practices relating to director compensation;
    • Director stock ownership guidelines and holding requirements;
    • Equity award vesting schedules;
    • The mix of cash and equity-based compensation;
    • Meaningful limits on director compensation;
    • The availability of retirement benefits or perquisites; and
    • The quality of disclosure surrounding director compensation.

Equity Plans for Non-Employee Directors. ISS currently recommends a vote on a case-by-case basis regarding compensation plans for non-employee directors. For 2017 annual meetings, ISS revised its existing policy to clarify and broaden the various factors considered when assessing the reasonableness of non-employee director equity plans. In particular, ISS added two new factors to consider: relative pay magnitude and meaningful pay limits.

Under its new policy, ISS will recommend a vote on a case-by-case basis on compensation plans for non-employee directors based on:

  • The total estimated cost of the company's equity plans relative to industry/market cap peers, measured by the company's estimated SVT based on new shares requested, plus shares remaining for future grants, plus outstanding unvested/unexercised grants;
  • The company's three-year burn rate relative to its industry/market cap peers; and
  • The presence of any egregious plan features (such as an option repricing provision or liberal change-of-control vesting risk).

ISS noted that, on occasion, director stock plans will exceed the plan cost or burn rate benchmarks when combined with employee or executive stock plans. In such cases, ISS will recommend a vote on the plan on a case-by-case basis taking into consideration the following qualitative factors:

  • The relative magnitude of director compensation as compared to companies of a similar profile;
  • The presence of problematic pay practices relating to director compensation;
  • Director stock ownership guidelines and holding requirements;
  • Equity award vesting schedules;
  • The mix of cash and equity-based compensation;
  • Meaningful limits on director compensation;
  • The availability of retirement benefits or perquisites; and
  • The quality of disclosure surrounding director compensation.

ISS's vote recommendation will be based upon the holistic approach of reviewing all of the factors, rather than requiring that all enumerated factors meet certain minimum criteria.

Glass Lewis

Overboarded Directors. Beginning in 2017, Glass Lewis will generally recommend voting against a director who serves as an executive officer of any public company while serving on a total of more than two public company boards and any other director who serves on a total of more than five public company boards. 

Glass Lewis will consider relevant factors when determining whether a director's service on a number of boards may limit the ability of the director to devote sufficient time to board duties.  Glass Lewis will consider the size and location of other companies where the director serves on the board, the director's board duties, whether the director serves on the board of any large privately-held companies, the director's tenure on the boards, and the director's attendance record at all companies. 

Glass Lewis's recommendation will also consider the rationale for serving on multiple boards.  As such, Glass Lewis recommends that the company provide sufficient rationale for the director's continued board service, which should allow shareholders to evaluate the scope of the director's other commitments as well as their contributions to the board, including specialized knowledge of the company's industry, strategy or key markets, the diversity of skills, perspective and background they provide, and other relevant factors.

Governance Following an IPO or Spin-Off. Glass Lewis generally reviews the terms of a company's governing documents in order to determine whether shareholder rights are being severely restricted from the outset. In particular, Glass Lewis will review anti-takeover mechanisms, supermajority vote requirements, and general shareholder rights such as the ability of shareholders to remove directors and call special meetings.

In cases where governing documents significantly restrict the ability of shareholders to effect change, Glass Lewis will consider recommending that shareholders vote against the members of the governance committee or the directors that served at the time of the governing documents' adoption, depending on the severity of the concern. 

Board Evaluation and Refreshment. For 2017 annual meetings, Glass Lewis reiterated its approach to board evaluation by clarifying that it believes a robust board evaluation process—one focused on the assessment and alignment of director skills with company strategy—is more effective than solely relying on age or tenure limits.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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