ISS and Glass Lewis Update Their Proxy Voting Guidelines

Jason Martinez and Davis Roach

Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis), two of the leading providers of corporate governance research and proxy voting services, have published their updated proxy voting guidelines for 2015. Both companies focused their updates on governance issues, including unilateral bylaw and charter amendments, as well as litigation rights, compensation, and environmental issues.    

ISS Proxy Voting Guidelines for 2015

The ISS updates to its proxy voting guidelines are effective for annual meetings on or after February 1, 2015. ISS released updates for the United States as well as the Canadian, European, and Asian-Pacific markets, but this alert will focus only on the United States updates.

The most significant updates to the ISS proxy voting guidelines include:

• Unilateral bylaw/charter amendments;
• Independent chair shareholder proposals;
• Litigation rights, including fee-shifting bylaw provisions; 
• Equity-based and other incentive plans; and
• Political contributions and greenhouse gas emissions.

Unilateral Bylaw/Charter Amendments

ISS will generally recommend voting “against” or “withhold” for individual directors, committee members or the entire board (except, potentially, new nominees) if the board amends the company’s charter or bylaws without shareholder approval in a manner that materially diminishes shareholders’ rights or that could adversely impact shareholders. ISS will consider any relevant factor in its decision, including the following:

• The board’s rationale for adopting the amendment without shareholder approval;
• The company’s disclosure of any significant engagement with shareholders regarding the amendment;
• The extent of impairment to shareholder rights resulting from the board’s unilateral amendment;
• The track record of the board with regard to unilateral action on bylaw/charter amendments or other entrenchment provisions;
• The company’s ownership structure;
• Existing company governance provisions;
• Whether the amendment was made before or in connection with the company’s IPO;
• The timing of the amendment to the bylaws or charter in connection with a significant business development; and
• Any other factors that may be relevant to determine the impact of the amendment on shareholders.

ISS decided to update its stance on unilateral bylaw/charter amendments based on its observation of a substantial increase in the amount of bylaw/charter amendments that were adopted without shareholder ratification. The substantial increase in such amendments is partly due to the recent trend of companies adopting bylaw and/or charter amendments right before, or in conjunction with, their IPOs.  

Independent Chair Shareholder Proposals

ISS will generally recommend a vote “for” shareholder proposals requiring that the chairman’s position be filled by an independent director. ISS will take the following into account, among other things: 

• Scope of the Proposal – whether precatory or binding and whether immediate or in connection with next CEO transition;
• Current Board Leadership Structure – the presence of an executive or non-independent chair, a recent recombination of the role of CEO and chair, or the departure from a structure with an independent chair;
• Governance Structure and Practices – overall independence of board and key committees, establishment of governance guidelines, board tenure and relationship to CEO tenure;
• Performance of the Company – one, three and five-year total returns compared to peers and market; and
• Any other relevant factors.

ISS updated its stance on shareholder proposals requiring that the chairman’s position be filled by an independent director because this type of shareholder proposal was the most prevalent type of shareholder proposal at U.S. companies’ annual meetings in 2014. The new policy takes a more holistic approach, considering a wide range of mitigating factors for determining how ISS will recommend shareholders vote on such proposals.

Litigation Rights 

ISS will recommend voting case-by-case on bylaws that impact shareholders’ litigation rights, considering the following factors: 

• The company’s rationale for adopting the amendment;
• Disclosure of past harm from shareholder lawsuits in which plaintiffs were unsuccessful and/or the lawsuit was outside of the jurisdiction of incorporation;
• Types of lawsuits the bylaw amendment would apply to; and 
• Governance features, such as the shareholders’ ability to repeal the provision at a later date, and hold directors accountable through annual elections and a majority vote standard in uncontested elections.

ISS will generally recommend a vote “against” bylaws that mandate fee-shifting whenever plaintiffs are not completely successful on the merits. Unilateral adoption by the board of bylaw provisions which affect shareholders’ litigation rights will be evaluated under ISS’ policy on unilateral bylaw and charter amendments discussed above.

ISS updated this policy for a number of reasons, including that the Delaware legislature has not yet acted (as expected) to limit the applicability of a Delaware Supreme Court decision that allows companies to adopt fee-shifting bylaws to non-stock corporations. Due to the delay by the Delaware legislature, public companies are beginning to adopt these types of bylaw amendments by unilateral board action.

Compensation – Equity Based and Other Incentive Plans

ISS has decided to adopt a “scorecard” approach for equity plans. The “Equity Plan Scorecard” takes into account a wide range of positive and negative factors (instead of the previous pass/fail tests) to review proposals related to equity incentive plans. This new scorecard approach weighs positive and negative factors in three different main areas: plan cost, plan features, and grant practices.

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 in relation to its peers.

Plan Features – features such as automatic single-trigger award vesting on a change of control, discretionary vesting authority, liberal share recycling on various award types, and minimum vesting period for grants made under the plan.

Grant Practices – three-year burn rate relative to the company’s industry and market cap peers, vesting requirements in most recent CEO equity grants, estimated duration of the plan, proportion of the CEO’s most recent equity grants and awards subject to performance conditions, whether there is a clawback policy and whether there are post-exercise/vesting share holding requirements.

ISS will generally vote "against" the plan proposal if a combination of the above factors suggests that the plan is not in the best interest of shareholders, or if any of the following apply: 

• Awards may vest as a result of a liberal change-of-control definition;
• The plan would permit cash buyout or repricing of underwater options without shareholder approval (by expressly permitting it or by not prohibiting it);
• The plan provides an avenue for poor pay practices and/or pay-for-performance disconnect; or
• Any other plan feature that has a significant negative impact on shareholders.

Political Contributions and Greenhouse Gas Emissions

ISS will generally recommend a vote "for" proposals requesting more disclosure of a company’s trade associations spending policies and activities or its political contributions. Factors that ISS will consider when recommending a vote on such proposals are:

• The company’s policies and oversight related to its direct political donations and funds paid to other groups or entities for political purposes;
• The company’s disclosure of its support and/or participation in groups or entities that make political contributions; and
• Recent significant litigation, fines, or controversies regarding the company’s political activities and/or political contributions.

ISS will consider proposals that request the adoption of greenhouse gas reductions goals for emissions from the company’s products and operations on a case-by-case basis. ISS will consider the following factors:

• Whether or not the company discloses on a yearly basis its greenhouse gas emissions performance data;
• If the company’s disclosure is less than industry peers; 
• The company's actual greenhouse gas emission performance;
• The company's current greenhouse gas emission policies, oversight mechanisms and related initiatives; and
• Whether the company has been the subject of recent and significant litigations, violations, or fines related to greenhouse gas emissions.

Glass Lewis Policy Guidelines for the 2015 Proxy Season

Glass Lewis has released updates, which are generally effective for annual meetings after January 1, 2015, related to the following areas:

• Governance committee performance;
• Board responsiveness to majority-approved shareholder approvals;
• Vote recommendations following an IPO;
• Standards for assessing “material” transactions with directors;
• Advisory votes on executive compensation; and
• Employee stock purchase plans.

Governance Committee Performance

Where a board amends, without shareholder approval, the company’s governing documents to reduce or remove important shareholder rights, or to otherwise impede the ability of shareholders to exercise these rights, depending on the circumstances, Glass Lewis may recommend that shareholders vote "against" the chairman of the governance committee or "against" the entire governance committee. Examples of actions that could cause a vote "against", include:

• Eliminating the ability of shareholders to call a special meeting or act by written consent;
• Increasing the ownership threshold required for shareholders to call a special meeting;
• Increasing vote requirements for charter or bylaw amendments;
• Adopting provisions that limit the ability of shareholders to pursue full legal recourse, such as bylaws that require either of the following:
• Arbitration of shareholder claims; or
• Shareholder plaintiffs to pay the company's legal expenses in the absence of a court victory (i.e., "fee-shifting" or "loser pays" bylaws);
• Adopting a classified board structure; or
• Eliminating the ability of shareholders to remove a director without cause.

In addition, Glass Lewis believes that amendments to a company’s charter or bylaws that restrict a shareholder’s choice of legal venue are not in the best interests of shareholders because such amendments essentially discourage shareholders from bringing claims against the company by increasing the cost of litigation. As a result, Glass Lewis will generally recommend a vote "against" an exclusive forum amendment unless the company: (1) provides a compelling argument for why the provision would directly benefit shareholders, (2) provides evidence of abuse of legal process in other jurisdictions besides the favored jurisdiction, (3) narrowly tailors such amendment to the appropriate risks involved, and (4) maintains a strong and appropriate corporate governance practices.

Glass Lewis strongly opposes fee-shifting bylaws because it believes they discourage even meritorious shareholder lawsuits by providing a financial disincentive to sue the company. Glass Lewis, therefore, will generally recommend voting "against" the members of the governance committee if a fee-shifting bylaw is adopted without shareholder approval.

Board Responsiveness to Majority-Approved Shareholder Approvals

Glass Lewis’ current policy is to recommend that shareholders vote "against" members of the board if during such members’ board tenure a shareholder proposal regarding important shareholder rights was approved by a majority of shareholders, but then the board did not properly respond to such majority approval. Glass Lewis has now expanded this policy to specify that, in determining whether a board has sufficiently implemented a proposal, Glass Lewis will examine the quality of the right enacted or proffered by the board for any conditions that may unreasonably interfere with the shareholder’s ability to exercise the right (e.g., overly prescriptive procedural requirements for calling a special meeting).

Vote Recommendations Following an IPO

While Glass Lewis will generally refrain from issuing voting recommendations during the one-year period after an IPO, it has now decided that it will scrutinize certain provisions adopted prior to an IPO. Specifically, Glass Lewis will:

• Consider recommending a vote "against" all board members who served at the time of adoption of an anti-takeover provision, such as a poison pill or classified board, if the provision is not put up for shareholder vote after the IPO; and
• Recommend that shareholders vote "against" the governance committee chair in the case of an exclusive forum provision passed before an IPO and "against" the entire governance committee in the case of a fee-shifting bylaw provision passed before an IPO, unless these provisions are put to a shareholder vote following the IPO.

Assessing “Material” Transactions with Directors

Glass Lewis has a $120,000 materiality threshold in place for directors employed by professional services firms (e.g., law firms, investment banks or consulting firms) where the company pays the firm and not the individual for services. Glass Lewis updated this policy so that the transaction will be deemed immaterial if the amount paid to the firm is less than 1% of such firm’s annual revenues and the board provides a compelling reason as to why the director’s independence is not affected.

Advisory Vote on Executive Compensation

Glass Lewis generally believes that shareholders should be wary of awards granted outside a company’s standard incentive schemes. However, Glass Lewis recognizes that, in certain circumstances, additional incentives may be appropriate. To that end, Glass Lewis recommends that companies that make grants outside standard incentive schemes should provide a thorough description of the awards, including a cogent and convincing explanation of their necessity and the reason why existing rewards do not provide sufficient motivation. In addition, companies should tie the awards to future service and performance, if possible, and describe if and how the regular compensation arrangements will be affected by the supplemental awards. Glass Lewis will review the terms and size of the awards in the context of the company’s overall incentive strategy, as well as its current operating environment. 

Employee Stock Purchase Plans

Glass Lewis also clarified its policy on reviewing employee stock purchase plans (ESPPs). Specifically, Glass Lewis will generally recommend a vote "against" ESPPs that contain evergreen provisions that automatically increase the number of shares available each year under the ESPP. Glass Lewis will generally support ESPPs in compliance with the regulatory purchase limit of $25,000 per employee per year, which Glass Lewis considers reasonable. It also looks at the number of shares requested to see if either (i) an ESPP will significantly contribute to overall shareholder dilution or (ii) shareholders will not have a chance to approve the program for an excessive period of time.