Client Alert
ISS and Glass Lewis Voting Guidelines: 2015 Updates
December 08, 2014
BY TERI O’BRIEN, ELIZABETH RAZZANO & NAUSHEEN SHAIKH
Proxy advisory firms Institutional Shareholder Services (ISS) and Glass Lewis & Co. (Glass Lewis) recently released updates to their respective voting guidelines for the 2015 proxy season. The key changes to the voting guidelines for ISS[1] relate to the unilateral adoption of bylaw and charter amendments by the board of directors, exclusive forum and fee-shifting bylaw provisions, proposals calling for the separation of the chairman and chief executive officer positions, evaluation of equity-based compensation plans, increased disclosure regarding political contributions and trade association relationships, and evaluation of greenhouse gas emissions information. The key changes for Glass Lewis[2] relate to unilateral adoption of bylaw and charter amendments by the board of directors, the board of directors’ responsiveness to majority-approved shareholder proposals, voting recommendations for anti-takeover provisions following an initial public offering, standards for assessing material transactions with directors, one-off incentive compensation awards, and employee stock purchase plans.
Effective Dates
The ISS policy updates will be effective for meetings held on or after February 1, 2015. Glass Lewis’ revised guidelines will be effective for meetings held after January 1, 2015.
ISS Updates
Bylaw and Charter Amendments Without Shareholder Approval
Previously, ISS recommended that shareholders vote against or withhold votes for individual directors, committee members or the entire board in director elections that took place following, among other things, certain failures in corporate governance. The unilateral amendment (i.e., the amendment without shareholder approval) of bylaws or charter provisions in a manner that ISS considered to adversely affect shareholders was historically considered to be such a corporate governance failure.
ISS is now adopting a standalone policy to address the unilateral adoption of bylaw and charter amendments by boards of directors. According to ISS, this update was spurred, in part, by the recent increase in the number of “shareholder-unfriendly” bylaw and charter amendments that companies have passed without seeking shareholder ratification, shortly before, or on the date of, their initial public offering (IPO).
Under the new standalone policy, ISS will generally recommend that shareholders vote against or withhold votes for individual directors, committee members, or the entire board (except new nominees, who will be considered on a case-by-case basis) if the board amends the company’s bylaws or charter, without shareholder approval, in a manner that “materially diminishes shareholders’ rights or that could adversely impact shareholders.” Provisions that might fall under this policy include, without limitation, bylaw provisions that adversely impact shareholders’ litigation rights and bylaws removing the shareholders’ right to call a special meeting. In making its determination, ISS will consider the following factors, as applicable:
The board’s rationale for adopting the amendment without shareholder ratification;
The company’s disclosure of any significant engagement with shareholders regarding the amendment;
The level of impairment of shareholders’ rights caused by the amendment;
The board’s track record with regard to unilateral board action on bylaw and charter amendments or other entrenchment provisions;
The company’s ownership structure and existing governance provisions;
Whether the amendment was made prior to or in connection with the company’s IPO;
The timing of the amendment in connection with a significant business development; and
Any other relevant factors that ISS deems appropriate in determining the impact of the amendment on shareholders.
Directors considering the adoption of a bylaw or charter amendment without shareholder approval should assess whether the amendment could adversely impact shareholders and, if so, should consider how each of the above factors might influence future ISS recommendations. Companies that are considering such amendments prior to, during or immediately following an IPO should be especially cautious, as ISS’ stated rationale for the new policy suggests that such IPO-related amendments may be subject to increased scrutiny.
Protection of Shareholders’ Litigation Rights
In response to recent case law in support of bylaw provisions that impact shareholders’ litigation rights, including exclusive forum[3] and fee-shifting bylaws,[4] companies have been adopting such bylaw provisions at a steady pace, prompting ISS to revise its policy with respect to situations where a company seeks stockholder approval of such provisions (as opposed to unilateral adoption by the board). Bylaw amendments passed without shareholder approval that could adversely impact shareholders’ litigation rights will be assessed under the new policy applicable to unilateral board amendments described above.
Exclusive forum provisions generally limit a stockholder’s ability to bring a lawsuit against the company, by requiring that derivative actions, fiduciary duty suits, and other claims regarding the internal affairs of a corporation be litigated exclusively in a designated forum (e.g., the company’s state of incorporation or headquarters). The purpose of such bylaw provisions is to minimize multi-forum litigation and the related expense companies incur litigating cases in multiple jurisdictions. Fee-shifting bylaws generally require a shareholder who sues the company unsuccessfully to pay the company’s litigation expenses. A 2014 Delaware Supreme Court decision, ATP Tour, Inc. v. Deutscher Tennis Bund,[5] played an important role in prompting companies to adopt such fee-shifting bylaws.
Under its former policy, ISS recommended how to vote on exclusive forum proposals on a case-by-case basis after taking highly specific factors into account. ISS is now expanding its policy to address fee-shifting bylaws, as well as other provisions affecting shareholders’ litigation rights (e.g., mandatory arbitrary provisions).
Under the expanded policy, ISS will recommend a vote on a case-by-case basis on bylaws which materially impact shareholders’ litigation rights, taking into account factors such as:
The company’s stated rationale for adopting the provision;
The company’s disclosure of past harm from shareholder lawsuits in which plaintiffs were unsuccessful or shareholder lawsuits outside the company’s jurisdiction of incorporation;
The breadth of application of the bylaw, including the types of lawsuits to which it applies and the definition of key terms; and
Governance features related to the bylaw, such as the ability of shareholders to repeal the provision and their ability to hold directors accountable.
In addition, ISS will generally recommend a vote against bylaws that mandate fee-shifting in situations where a plaintiff is not completely successful on the merits (i.e., partially successful).
Companies should keep the above factors in mind when discussing and drafting fee-shifting bylaws or other bylaws that affect shareholders’ litigation rights. In addition, companies considering adoption of fee-shifting bylaws should be aware that uncertainty surrounds the future legality of such provisions.[6] The 2014 Delaware Supreme Court decision could be interpreted narrowly to only apply in specific contexts or be limited by statute.[7]
Proposals for an Independent Chairman
Previously, ISS generally recommended a vote for shareholder proposals requiring that the chairman’s position be filled by an independent director, unless the company satisfied six criteria.
The number of shareholder proposals calling for an independent board chair has increased significantly over the past five years, and such proposal was the most prevalent type of shareholder proposal offered for consideration at 2014 annual meetings.[8] In light of this recent focus on independent leadership and concerns as to whether the presence of a lead independent director is an effective counterbalance in situations where the chairman and chief executive officer roles are held by one individual, ISS has decided to apply a more “holistic review” with respect to such proposals.
Under its updated policy, ISS will generally recommend a vote for shareholder proposals requiring that the chairman’s position be filled by an independent director after taking into consideration the following factors, as well as any other factors that may be relevant:
The scope of the proposal, including whether the policy is precatory or binding and the timing of implementation;
The company’s current board leadership structure, including whether there is currently a non-independent chairman in addition to the chief executive officer and any recent transitions in board leadership;
The company’s governance structure and practices, including the overall independence of the board and key committees, board tenure, compensation practices, and any other practices that suggest a need for more independent oversight; and
The company’s performance, which is generally assessed based on one-, three-, and five-year total shareholder return compared to the company’s peers and the market as a whole.
Under this more holistic approach, single factors that may have otherwise been outcome determinative (both positive and negative) may now be mitigated by the existence of opposing factors.
Evaluation of Equity Plans
Under its previous policy, ISS generally made recommendations for equity-based compensation plans on a case-by-case basis but would automatically vote against a plan if certain conditions existed. More specifically, ISS applied a number of standalone tests primarily focused on cost and certain compensation practices for determining when to recommend a vote against a compensation plan. Under the updated policies, ISS will be taking a more nuanced approach toward assessing equity plan proposals by adopting a scorecard system—the Equity Plan Scorecard (EPSC)—which takes into account a range of factors (both positive and negative) related to plan features and a company’s prior grant practices.
The EPSC evaluates plans by balancing certain factors under the three “EPSC pillars” set forth below. Each pillar has its own specific factors to be considered and is weighted as indicated for S&P 500 and Russell 3000 companies.
Plan Cost
(45%)
Plan Features
(20%)
Grant Practices
(35%)
Shareholder value transfer (SVT) compared to peers
SVT based on the number of shares being requested plus shares available for grant under existing plans plus outstanding awards
SVT based only on new shares requested plus shares available for grant under existing plans
Single trigger vesting on a change in control
Liberal share recycling practices
Minimum vesting
Vesting discretion for non-change in control events
Three year burn rate compared to industry and market cap peers
Vesting for CEO equity grants for the past three years
Estimated plan duration
Existence of a clawback policy
Existence of stock ownership requirements
Performance grant ratio for CEO
ISS will make recommendations on a case-by-case basis using the score generated by the EPSC and will recommend a vote against a proposal if a combination of the above factors is not, overall, determined to be in the best interests of the shareholders. In addition, certain plan features will continue to result in an automatic recommendation against a plan, such as problematic pay practices and other plan features that are determined to have a significant negative impact on shareholder interests.[9]
Alternative weightings of the “EPSC pillars” will be applied to non-Russell 3000 companies and companies that recently went public or emerged from bankruptcy. Additional information about this policy and alternative weightings is expected to be published in December 2014 under ISS’ Executive Compensation FAQ.
Political Contributions and Trade Association Relationships
ISS has updated its former policy relating to political contributions. Although it will continue to recommend a vote for proposals requesting greater disclosure of a company’s political contributions and trade association spending policies and activities, it is now specifying the types of oversight mechanisms that are reviewed and requiring more specific disclosure regarding trade association relationships. Under its updated policy, ISS will consider the following factors:
The company’s policies and management and board oversight related to its direct political contributions and payments to trade associations or other groups that may be used for political purposes;
The company’s disclosure of its support of, and participation in, trade associations or other groups that may make political contributions; and
Any recent significant controversies, fines, or litigation related to the company’s political contributions or political activities.
Greenhouse Gas Emissions
ISS has updated its former policy on greenhouse gas emissions (GHG) by eliminating certain factors covered by other ISS policies, incorporating investor feedback, and requiring year-over-year disclosure on GHG emissions. Under its updated policy, ISS will continue to recommend a vote for proposals calling for the adoption of GHG reduction goals from company products and/or operations on a case-by-case basis and will consider the following factors:
Whether the company provides disclosure of year-over-year GHG emissions performance data, and whether the company’s disclosures lag behind industry peers;
The company’s actual GHG emissions performance;
The company’s current GHG emission policies and related oversight mechanisms and initiatives; and
Whether the company has been the subject of recent significant violations, fines, litigation, or controversy related to GHG emissions.
Glass Lewis Updates
Governance Matters
Bylaw and Charter Amendments Without Shareholder Approval
Similar to ISS, Glass Lewis has adopted a policy under which it may recommend that shareholders vote against the governance committee chairman or the entire governance committee (depending on the circumstances) if the board adopts or amends a bylaw or charter provision without seeking shareholder approval to “reduce or remove important shareholder rights, or to otherwise impede the ability of shareholders to exercise such right[s].” Actions of a board of directors that may result in such a recommendation include, without limitation, eliminating the shareholders’ right to call a special meeting, to act by written consent or to remove directors without cause, increasing the ownership threshold required for shareholders to call a special meeting, limiting the ability of shareholders to pursue full legal recourse (e.g., by adopting fee-shifting bylaws), adopting a classified board structure, or increasing voting requirements for amending the company’s charter or bylaws.
Board Responsiveness to Majority-Approved Shareholder Proposals
Glass Lewis will generally recommend a vote against all governance committee members if, during their tenure, a shareholder proposal relating to important shareholder rights (e.g., a proposal seeking a declassified board, a majority vote standard for director elections, or the shareholders’ right to call special meetings), received support from a majority of the votes cast (excluding abstentions and broker non-votes), and the board failed to implement, or has inadequately implemented, such proposal. Glass Lewis has expanded its policy on this issue to specify that in determining whether a proposal has been adequately implemented, it will look for any conditions that may unreasonably interfere with the shareholders’ ability to exercise the right subject to the proposal, such as “overly restrictive procedural requirements for calling a special meeting.”
Post-IPO Voting Recommendations
Glass Lewis typically offers a one-year grace period following an IPO during which it will not issue any voting recommendations on the basis of corporate government practices, including board independence, committee membership, and meeting attendance. Exceptions to this grace period have historically included (i) recommendations against board members who served at the time a poison pill was adopted, if the board did not commit to submit the poison pill to a shareholder vote within twelve months of the IPO, nor provide a sound rationale for adoption of the poison pill and the pill does not expire in three years or less, and (ii) recommendations against the governance committee chairman (or the board chairman, in the absence of a governance committee) who served at the time an exclusive forum provision was adopted by the board, in each case, if such provision was adopted pre-IPO.
Glass Lewis’ updated policy adds to the above exceptions. First, Glass Lewis will consider recommending a vote against board members if, during their pre-IPO tenure, the board adopted any anti-takeover provision (including, without limitation, poison pills or a classified board structure) and neither committed to submitting it to a shareholder vote within twelve months of the IPO, nor provided a sound rationale for its adoption. Secondly, Glass Lewis adds that it will recommend a vote against the entire governance committee (or the board chairman, in the absence of a governance committee) if, during their pre-IPO tenure, the board adopted a fee-shifting bylaw and such bylaw was not put up to a shareholder vote post-IPO.
Material Transactions with Directors and Impact on Independence
Glass Lewis assesses director independence based, in part, on the material financial relationship non-employee directors have with the company or professional services firms hired by the company that employ such directors (e.g., consulting firms, investment banks or law firms that receive fees from the company and employ its directors). In the latter case, Glass Lewis generally deems such a relationship to be material if the amount paid to the applicable professional services firm (not the directors themselves) exceeds $120,000. Glass Lewis has updated its assessment of director independence to clarify that the foregoing threshold may be deemed immaterial when such amount is less than 1% of the applicable professional services firm’s annual revenues and the board provides a compelling rationale as to why the director’s independence is not impacted by their relationship with such firm.
One-Off Incentive Compensation Awards
Glass Lewis has added guidance with respect to granting one-off compensation awards outside a company’s existing incentive program. Glass Lewis generally believes that shareholders should be wary of such awards and that, instead of granting one-off awards, companies should redesign their incentive programs. However, Glass Lewis acknowledges that it may be appropriate for companies to make one-off awards in some circumstances and instructs companies granting such awards to provide a thorough description and “a cogent and convincing explanation” of the necessity of such awards and of why existing awards do not provide sufficient motivation. In addition, Glass Lewis notes that such awards should be tied to future services and performance whenever possible and that it will review both the terms and size of such grants in the context of the company’s overall incentive compensation policy and practices and the current operating environment.
Evaluation of Employee Stock Purchase Plans
The 2015 guidelines describe the approach that Glass Lewis uses when evaluating employee stock purchase plans (ESPPs). Glass Lewis uses a quantitative model to estimate plan cost and compares it to the cost of ESPPs at similar companies. The cost of ESPPs is measured by the expected discount, purchase period, expected purchase activity, and any “lookback” feature of the plan. Glass Lewis views ESPPs favorably and will generally support such plans, given the regulatory purchase limit of $25,000 per employee per year. Glass Lewis also looks at the number of shares requested under the plan to gauge its potential dilutive effect and whether an excessive time period will pass before shareholders will have the opportunity to reconsider the program. Glass Lewis will generally recommend a vote against ESPPs that contain “evergreen” provisions (which automatically increase the number of shares available under the plan each year).
***
[1] The 2015 ISS Proxy Voting Guideline Updates, available at http://www.issgovernance.com/file/policy/2015USPolicyUpdates.pdf.
[2] The Glass Lewis Guidelines (2015 Proxy Season), available at http://www.glasslewis.com/assets/uploads/2013/12/2015_GUIDELINES_United_States.pdf.
[3] See Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013); see also City of Providence v. First Citizens BancShares, Inc., 99 A.3d 229 (Del. Ch. 2014).
[4] See ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014) (finding that fee-shifting provisions in the bylaws of a Delaware non-stock corporation can be valid and enforceable).
[5] See id.
[6] The Delaware legislature has postponed its consideration of legislation that would limit the holding in ATP Tour, Inc. to non-stock corporations until it reconvenes in 2015. In addition, the U.S. Securities Exchange Commission (SEC) is being asked to take action against fee-shifting bylaws. The issue was raised at an October 9, 2014 SEC Investor Advisory Committee meeting. It is not clear whether, and if so, how, the SEC will respond.
[7] The holding in ATP Tour, Inc. may be limited by Strougo v. Hollander, a breach of fiduciary duty case pending before the Delaware Chancery Court in which the plaintiff is challenging a fee-shifting provision in the defendant company’s bylaws. Strougo v. Hollander, No. 9770-CB (Del. Ch. Sept. 24, 2014) (Verified Amended Class Action Complaint).
[8] See, ISS’ 2015 U.S. Proxy Voting Guidelines Update. See also, Proxy Voting Fact Sheet, Rpt. No. PV-V3N3-14 (The Conference Board (July 2014)), available at https://www.conference-board.org/topics/publicationdetail.cfm?publicationid=2804.
[9] ISS will generally recommend a vote against a plan if any of the following apply: (i) awards vest in connection with a liberal change-of-control definition; (ii) 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); (iii) the plan is a vehicle for problematic pay practices or a pay-for-performance disconnect exists; or (iv) the plan contains other features that are determined to have a significant negative impact on shareholder interests.
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