On November 11, 2019, Institutional Shareholder Services, Inc. (“ISS”) published its proxy voting guidelines updates1 (the “2020 Updates”) for the 2020 proxy season, effective for meetings on or after February 1, 2020. The changes notably establish new policies that address the governance of newly public companies, as well as clarify certain other existing policies that apply to all public companies. A summary of the new and revised policies is below.
Problematic Capital Structure – Newly Public Companies2
Under this newly-created separate policy for newly public companies, ISS will generally vote against or withhold from the entire board (except new nominees, who will be considered on a case-by-case basis) if, prior to or in connection with the company's IPO, the company or its board implemented a multi-class capital structure with unequal voting rights (e.g., dual class stock), unless this structure is subject to a “reasonable time-based sunset.” Factors that ISS will consider when assessing the reasonableness of a time-based sunset provision include the company’s lifespan, its post-IPO ownership structure and the board’s rationale for the period selected. However, “[n]o sunset period of more than seven years from the date of the IPO will be considered to be reasonable.”
Unless the problematic structure is changed, ISS will continue to vote against or withhold from incumbent directors in subsequent years.
ISS’ rationale for this change included the increasing prevalence of multi-class capital structure companies with disparate voting rights among newly-listed entities in the US and the results of ISS’ 2019 Global Policy Survey, in which 55 percent of investor respondents agreed that a maximum seven-year sunset is appropriate. The ISS policy, however, is unlikely to impact the prevalence of companies with dual class stock, since the high voting stock means that the “no” votes of public shareholders have little impact on the outcome of director elections.
Problematic Governance Provisions – Newly Public Companies
For newly public companies, ISS will generally vote against or withhold from directors, committee members, or the entire board (except new nominees, who will be considered on a case-by-case basis) if, in connection with an IPO, the company or its board adopted certain bylaw or charter provisions that are considered to be materially adverse to shareholder rights. The revised policy replaces the previously-included list of factors ISS would consider when evaluating such governance provisions with a list of specific provisions which will presumptively be considered materially adverse to shareholders rights as follows:
- Supermajority vote requirements to amend the bylaws or charter;
- A classified board structure; or
- Other egregious provisions.
A reasonable sunset provision will be considered a mitigating factor, and unless the adverse provision is reversed or removed, the 2020 Updates indicate voting on director nominees in subsequent years will be done on a case-by-case basis.
Board Accountability – Restrictions on Shareholders’ Rights to Amend Bylaws
Under existing ISS policy, ISS generally recommends against or withholding from members of the governance committee, if the company’s governing documents impose “undue restrictions on shareholders’ ability to amend the bylaws.” Such “undue restrictions” include an “outright prohibition on the submission of binding shareholder proposals” or having “share ownership requirements, subject matter restrictions, or time holding requirements in excess of [Securities and Exchange Commission (“SEC”)] Rule 14a-8.”
In response to an increase in the number of companies submitting proposals that would establish requirements in governing documents that exceed the requirements of SEC Rule 14a-8 for shareholders to submit binding bylaw amendments, ISS added the following to its existing policy:
- Submission of management proposals that would approve or ratify requirements in excess of SEC Rule 14a-8 for a shareholder to submit a binding bylaw amendment will generally be viewed as an insufficient restoration of shareholders’ rights; and
- ISS will generally recommend shareholders vote against or withhold from members of the governance committee until shareholders are provided with “an unfettered ability to amend the bylaws” or until a proposal providing for such unfettered right is submitted for shareholder approval.
Board Diversity
The one-year transition period for the US gender diversity policy has now passed, and absent a firm commitment from the company to achieve gender diversity within a year, ISS will recommend against the chair of the nominating committee (or other directors as appropriate) if the board lacks a female director. In addition, ISS clarified a commitment to achieve gender diversity from a board with no prior women directors will only be a mitigating factor for 2020, not beyond.
In addition, going forward, a company that had board gender diversity in the previous year but not in the current year will need to acknowledge the current lack of a gender-diverse board, and provide a firm commitment to re-achieving board gender diversity by the following year in order to avoid a withhold/against recommendation. To constitute a “firm commitment”, there must be a plan, with measurable goals, outlining how the board will achieve gender diversity.
Board of Directors – Independent Board Chair
In response to the fact that shareholder proposals for independent board chairs remain among the most common type of proposal offered for consideration at US companies’ annual general meetings, as well as responses to ISS' 2019 Global Policy Survey, ISS explicitly codified its approach to evaluating independent chair proposals.
The new policy specifically identifies the factors that will be given substantial weight as part of ISS’ holistic approach to these proposals, including a “majority non-independent board”, a “weak or poorly defined lead independent director role”, the “evidence that the board has failed to oversee and address material risks facing the company”, and a “material governance failure”.3 While ISS notes it will maintain a “holistic approach” to evaluating these proposals, the policy now explicitly states that these are the factors that will be given substantial weight. In addition to these factors, ISS will also consider the scope of the proposal, overall company performance and additional “overriding” factors which will be updated and relocated to ISS’s Policy FAQ document.
Share Repurchase Programs
In the 2020 Updates, ISS revised its policy of generally voting “for” open-market share repurchase plans by explicitly adding safeguards against the use of certain abusive practices.4 In the absence of these practices, support will generally be warranted for a grant of authority to the board to engage in a buyback.5
Notably, this policy will not affect most US domestic issuers, which can and do implement share buyback programs via board resolutions without shareholder votes. However, the policy change will affect those companies that are required by their regulators (such as certain financial institutions) or by the laws of their country of incorporation (such as certain companies incorporated in European countries) to receive shareholder approval to grant the board authority to repurchase shares. ISS explicitly notes this policy will also cover foreign-incorporated US domestic issuers if they are listed solely in the United States, regardless of their country of incorporation.
Other Changes
ISS Approach to “New Nominees”
In addition to the changes above, ISS made three clarifications with respect to its approach to “new nominees.” Specifically, the 2020 Updates:
- Revised the definition of “new nominee” to clarify this is a director who is being presented for election by shareholders for the first time, rather than only a person who just joined the board (e.g., if a board is classified, a new nominee could have served on the board for up to three years depending on the class, and for newly-public companies, the director may have served for years on the board prior to the IPO);
- Clarified ISS policy that only the subset of new nominees who have served on the board for less than one year will be evaluated on a case-by-case basis under ISS’s Board Accountability policy, depending on the timing of their appointment and the problematic governance issue in question; and
- Removed the term “new nominee” from the director attendance policy, because the issue for recently-added directors under this policy is whether they served the entire fiscal year under review, not whether they have been previously elected by shareholders.
Equity Compensation Plans
In addition, the 2020 Updates specifically add the existence of an “evergreen (automatic share replenishment) feature” to its list of egregious factors that will lead to a vote “against” an equity-based compensation plan.6
Gender Pay Gap Proposals
The 2020 Updates add a specific reference to “race or ethnicity” to its policy on gender-pay gap proposals, to better align it with the requests of filed shareholder proposals.
Conclusion
Notably, in contrast to Glass Lewis,7 ISS did not address the new SEC policy on Rule 14a-8 no-action requests or provide any insight into how it will respond if a company chooses to exclude a shareholder proposal where the SEC has declined to state a view on the company’s no action request.
The 2020 Updates are effective for meetings on or after February 1, 2020, and the fully revised guidelines for 2020, incorporating the changes described above, are expected to be posted on the ISS website by January 2020.
1 Policy updates for the Americas, which are described herein, available here. ISS posts 2020 policy updates for additional regions here. Current voting policies are available here.
2 ISS policy states that “[n]ewly-public companies generally include companies that emerge from bankruptcy, spin-offs, direct listings, and those who complete a traditional initial public offering (“IPO”).”
3 The complete list of factors that will increase the likelihood of a “for” recommendation in favor of a shareholder proposal calling for an independent board chair are as follows:
- “a majority non-independent board and/or the presence of non-independent directors on key board committees;
- weak or poorly-defined lead independent director role that fails to serve as an appropriate counterbalance to a combined CEO/chair role;
- the presence of an executive or non-independent chair in addition to the CEO;
- a recent recombination of the role of CEO and chair; and/or departure from a structure with an independent chair;
- evidence that the board has failed to oversee and address material risks facing the company;
- a material governance failure, particularly if the board has failed to adequately respond to shareholder concerns or if the board has materially diminished shareholder rights; or
- evidence that the board has failed to intervene when management’s interests are contrary to shareholders' interests.”
4 These practices include: (1) the use of targeted share buybacks as greenmail or to reward company insiders by purchasing their shares at a price higher than they could receive in an open market sale, (2) the use of buybacks to inappropriately manipulate incentive compensation metrics (i.e. boost EPS or other compensation metrics to increase payouts to executives or other insiders), and 3) repurchases that threaten a company's long-term viability (or a bank's capitalization level).
5 The 2020 Updates also state ISS will vote case-by-case on proposals to repurchase shares directly from specified shareholders, “balancing the stated rationale against the possibility for the repurchase authority to be misused, such as to repurchase shares from insiders at a premium to market price.”
6 This is responsive to the Tax Cuts and Jobs Act’s repeal of the performance-based pay exemption, which then eliminated the need for companies to obtain shareholder regular re-approval of plans. As a result of the tax reform, ISS found there has been a significant drop in the number of equity plans brought to shareholder vote (a 27 percent year-over-year drop from 2017 to 2018), and the number of such proposals in 2018 and 2019 has remained significantly below levels seen before the tax reform.
7 For information Glass Lewis’ policy, see our prior alert “Glass Lewis Issues Proxy Voting Guidelines for the 2020 Proxy Season.”
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© 2019 White & Case LLP
