The proxy season is just around the corner for calendar year public companies. Ahead of the season, two major proxy advisory firms, Institutional Shareholder Services (ISS) and Glass Lewis, recently released their 2019 policy updates to provide guidance on how they will make recommendations on companies’ “say-on-pay” vote. Although a non-binding vote, performing poorly on a say-on-pay vote is not only disheartening, but can impact shareholder votes on election of directors (particularly compensation committee members), result in greater scrutiny of CEO performance, and require management and compensation committee members to expend significant time and resources to address concerns reflected by the vote.
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Subscribe to ISS RSS FeedISS Issues Benchmark Policies for 2019 and Bipartisan Bill to Regulate Proxy Advisory Firms is Proposed
New ISS Policies. For meetings on or after February 1, 2019, two new and fairly minimal ISS policies will be applied.
As part of ISS’ client roundtables, one-to-one client discussions and public comment period on proposed policy changes, ISS discussed the potential use of Economic Value Added (EVA) metrics to assess company performance in executive compensation evaluations. In its policy update, ISS explained that many institutional investors agreed with the notion of exploring the potential of EVA factors to add insight into company performance beyond total shareholder return (TSR) and GAAP measures, but that feedback received indicated that investors would like more time to understand the EVA methodology.
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ISS QualityScore Data Verification Opens; New Factors Added
ISS QualityScore Data Verification opened on Monday, November 5. Companies should be aware of the new Board Diversity Subcategory, which consists of four new factors and five existing factors that will take effect on November 29, 2018. The four new factors are:
- How many women serve in leadership roles on the board? The factor evaluates the number of women serving as board chair, chair of key committees or lead director.
- How many women are named executive officers (NEOs) at the company? Companies without any women as NEOs will lose credit, and credit will be capped for companies having more than two.
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ISS Proposes Limited Policy Updates for 2019 Related to Board Gender Diversity and Say-on-Pay Secondary Screens
Two key, but limited, policy changes for U.S. companies have been proposed by ISS. The open comment period will run through 5:00 p.m. ET on November 1.
Board Gender Diversity. Beginning with meetings on or after February 1, 2020 (providing a year grace period), ISS may issue adverse voting recommendations against nominating committee chairs at boards with no gender diversity. In special circumstances, the policy would allow the absence of board gender diversity to be temporarily explained and excused.
The mitigating factors that may be considered include: (a) a firm commitment, as stated in the proxy statement and/or other SEC filings to appoint at least one female director to the board in the near term (before the next annual general meeting); (b) the presence of at least one female director on the board at the immediately preceding annual meeting; and/or (c) any other compelling factors considered relevant on a case-by-case basis.
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CII and ISS Team Up to Oppose House Legislation on Proxy Advisory Firms, Speak for “Real Main Street” Investors
Protect the Voice of Shareholders aims to oppose H.R. 4015, the Corporate Governance Reform and Transparency Act, that passed the House last October. While not effective, the Act is perhaps best known for requiring that the SEC withdraw the no-action letters to Egan Jones and ISS, which the SEC itself undertook recently, as we previously discussed.
The site is a joint project of ISS and CII, with ISS responsible for the content with approval from CII. The goal is to “correct the record, reveal the mistruths and double-speak of the lobbying groups trying to mislead lawmakers.” According to the site, the Act would “allow boardrooms to inhibit” the distribution of research reports when they disagree with recommendations, arguing that it is “inappropriate to permit companies to hinder the current free flow of unbiased research and information to investors.” The site provides news and resources as well as a way to reach Congress to oppose the Act.
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ISS Releases Responses to Policy Survey
ISS announced the results of its high-level policy survey. The results will inform the new and updated policies for the 2019 proxy season, which is usually released in November.
Auditors and Audit Committee. ISS asked whether additional indicators of audit quality and independence would be useful in addition to considering non-audit services and fees when assessing auditor independence. Investors most often cited regulatory fines or other penalties on the auditor for weaknesses or errors in audit practices, or significant audit controversies, as important matters of interest. The third most favored factor was the identity of the audit partner and any links to the company or its management.
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In Advance of Roundtable, SEC Withdraws Letters on Investment Advisers’ Reliance on Proxy Advisory Firms for Voting Recommendations
The SEC issued a statement today announcing that its Division of Investment Management has rescinded the letters issued in 2004 to ISS and Egan-Jones, effective immediately.
The letters have been criticized to have unintentionally resulted in the endorsement of investors using proxy advisory firms in making proxy voting recommendations, in order to address potential conflicts of interests by investment advisers exercising their fiduciary obligations when voting proxies. In them, the SEC staff stated that the recommendations of a third party, independent of an investment adviser, may “cleanse” the adviser’s vote from conflict, as we explained in a post more than five years ago.
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ISS Detailed Policy Survey Addresses Independent Chair Proposals, Board Matrix and Compensation – Part II
In additional to the high-level questions in its global policy survey which we previously discussed here, ISS also included a more detailed set of questions for the U.S. that addresses:
Independent Chair Shareholder Proposals. ISS generally supports these proposals after taking into account factors such as the company’s governance structure and practices as well as financial performance. The survey asks about the level of importance that respondents may attach to the following factors when evaluating independent chair proposals: controversies and/or risk oversight failures; independence of key board committees; board’s rationale for having a combined CEO/chair structure; shareholder rights such as special meetings and proxy access; prevalence of takeover defenses; alignment between CEO pay and performance; board responsiveness to shareholder concerns; management of environmental and social issues; and the company’s short- and long-term TSR performance.
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ISS Policy Survey Covers Possibility of Tracking Directors and Additional Audit Committee Evaluations – Part I
The ISS annual global policy survey for 2018 includes only a few issues compared to prior years, but with more focus on the election of directors. The responses to the survey will inform the new policies that govern the 2019 meetings.
The survey is again being undertaken in two parts, one covering fundamental and high-profile topics which we address in this post, and another focused on details which we will describe in Part II.
The first set closes on August 24, and the second ends on September 21. You can access and respond to the survey here.
Auditors and Audit Committee.
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ISS Updated FAQs Focus on Proxy Reports and Engagements
U.S. proxy reports are issued 13 to 30 calendar days before a shareholder meeting, but closer to 13 to 18 days during April to June due to the volume, according to the most recent ISS FAQs on U.S. Proxy Voting Research Procedures and Policies. Updated Q&As are highlighted in the report.
Several revisions relate to engagement with ISS and changing vote recommendations, both timely topics for the current stage of the proxy season. ISS already provides guidance on how issuers should engage with them. A few insights from the FAQs include:
- Requests for engagement should be made by emailing the Research Helpdesk with (a) a detailed agenda, (b) a list of the company’s participants and (c) preferred dates and times.
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Environmental and Social Metrics Added to ISS QualityScore
Along with its four pillars for governance which score companies on a one to ten scale, ISS has launched Environmental & Social (E&S) QualityScore to measure corporate disclosure on environmental and social issues. Similar to the Governance QualityScore, the measures are relative based on peer companies within a specific industry group.
An initial set of 1,500 companies is being covered globally, including Energy, Materials, Capital Goods, Transportation, Automobiles & Components, and Consumer Durables & Apparel. It is expected that by Q2 2018, an additional 3,500 companies across 18 industries will be included. The scores will be part of the companies’ proxy voting reports, but like all of the QualityScores, will not impact the vote recommendations.
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ISS Launches Corporate Profile Products for Investors that Includes More Focus on Individual Directors, a Board Skills Matrix and QualityScore Analysis
Recently, ISS announced a new product for investors, called corporate due diligence profiles, that contains a historical review of past ISS recommendations and vote results, measurements of company governance and compensation practices against QualityScore best practices with red flags indicating deviations, as well as charts of each director’s tenure against the TSR at the public companies where that director serve.
We understand from ISS that the product was designed to meet investor demands in reviewing companies for possible shareholder engagement and seeking more insight on individual directors. While the overall data is not new, as the report aggregates information primarily from prior ISS reports and QualityScore into new formats, companies will likely want to be aware of they are being perceived by investors.
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ISS Releases Additional Guidance on 2018 Policy Updates
As discussed in a November post, ISS recently published its 2018 policy updates, effective for meetings held on or after February 1, 2018. Last week, the proxy advisory firm released further guidance in the form of three revised policy supplements.
- Pay-for-Performance Mechanics. ISS’ December Pay-for-Performance Mechanics whitepaper describes a revised methodology for 2018 pay-for-performance evaluations. Key 2018 updates include: (a) the introduction of the Financial Performance Assessment secondary quantitative screen; (b) changes to the pay-for-performance quantitative screens for S&P 500 companies; and (c) TSR smoothing for quantitative pay-for-performance screens.
- Financial Performance Assessment. The most notable change to ISS’ pay-for-performance methodology is the new quantitative Financial Performance Assessment, which compares a company’s financial and operational performance against its ISS peer group.
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Glass Lewis Updates Its Policy Guidelines
The board should take action when director elections or say-on-pay votes receive less than 80% support, according to the Glass Lewis updated policy guidelines:
Board responsiveness. Glass Lewis believes that boards should respond to any ballot item that receives more than 20% approval or dissent votes by shareholders, including say-on-pay, director elections and shareholder proposals. While the policy covers all three types of matters, the guidelines emphasized that it is particularly applicable for say-on-pay proposals and director elections. We urge Glass Lewis to recognize that it is highly common for shareholder proposals to receive more than 20% support, and taking negative action against all of those boards would cast a very broad and unwieldy net.
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ISS Policy Updates for 2018 Focus on Few Issues
ISS has issued its policy updates, effective for meetings held on or after February 1, 2018.
The updates are more limited in their scope compared to past seasons. ISS conducted a two-part survey process this year for the first time. We understand that many of the issues raised in the first survey were intended to be longer-term considerations, and did not result in updated voting guidelines for next year. These include the appropriateness of capital structures other than one-share, one-vote, board gender diversity, and virtual or hybrid meetings.
We also understand that pay ratio disclosure will be noted, but does not inform any voting recommendations for 2018.
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ISS Requests Public Comments on a Few of the Policies to be Updated for 2018
ISS is seeking public comment on three policies that will impact U.S. companies with the comment period to close on November 9. It will release final policy updates, which will contain more than just these three changes, that will impact the 2018 season in the second half of November. We previously reported on the issues that were raised in two separate surveys here and here.
The key changes under consideration for the three policies now subject to comment include:
Non-Employee Director Compensation. Under the proposed new policy, ISS would recommend against the board committee members who are responsible for setting or approving non-employee director compensation when there are two or more consecutive years of “excessive” pay without a rationale or other mitigating factors.
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ISS Survey Results Focus on Possibility of Adverse Recommendations for Non-Employee Director Pay and Use of Realizable Pay in Say-on-Pay Analysis
In ISS’ secondary survey results announced yesterday, the focus was primarily on compensation. We previously discussed the larger survey results here. Final policy updates that apply to the 2018 season should be issued in November.
Non-employee Director Pay. The highest paid non-employee directors in 2017 received more than $2 million in annual compensation, compared to $260,000 for the median S&P 500 director. Investors who responded to the survey believe that non-employee director pay programs should be analyzed by comparing the pay received against (ranked by preference): the 4-digit GICS industry group, the relevant stock market index peers and all companies.
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Glass Lewis Will Not Incorporate Pay Ratio Data into Say-On-Pay Analysis in 2018
As year-end companies begin preparing to disclose pay ratio information in their 2018 proxy statements, Glass Lewis announced that it does not intend to make the ratio a part of the proxy advisor’s assessment of how investors should vote on say-on-pay “at this time” because it is not material for the analysis of the structures that companies use to pay their NEOs and the disclosures of those pay decisions. The information will be included in the Glass Lewis reports as a data point since shareholders may consider it useful insight into a company’s practices.
The firm notes the two sides of the argument on the importance of the pay ratio.
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ISS Survey Results Provide Investor Sentiments on Hot Topics, Including Pay Ratio and One Share-One Vote, and May Influence Next Year’s Voting Guidelines
ISS received 602 responses from 572 organizations, including 121 institutional investors, on its governance survey. Key findings on the governance principles survey are set forth below. ISS also asked more detailed questions in a supplemental survey, which is still open until October. These survey responses may inform ISS’ voting policies, and updates are generally issued in November.
One-Share, One-Vote. Among investors, 43% indicated that they find unequal voting rights never appropriate for public companies in any circumstances. Another 43% said unequal voting rights structures may be acceptable for newly-public companies if they are subject to automatic sunset requirements, or at other public companies if the capital structure is put up for periodic reapproval by the holders of the low-vote shares.
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The Drivers that Continue to Dog Say-on-Pay
Although the failure rate for 2017 say-on pay results achieved an all-time low of just 1.3%, the number belies the fact that more than 2,000 say-on pay proposals have either received negative recommendations from ISS or less than 70% support, or both, since say-on-pay resolutions started in 2011.
Approximately 12% to 14% of companies run into problems every year. As companies have become more proactive with shareholder engagement, the number of companies that received “against” recommendations from ISS and still achieved more than 70% support has increased in the last three years, while the number of companies with those negative recommendations that received less than 70% favorable votes have fallen.
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ISS Detailed Benchmark Survey Focuses on Governance Debates Largely Surrounding Pay Topics – Part II
For US companies, the detailed portion of the ISS benchmark survey targets compensation matters, along with one question on poison pills:
Short-Term Poison Pills. ISS asks whether it should continue its approach of examining poison pills with less than a one-year term on a case-by-case basis when voting on director elections or whether they are generally acceptable.
Using Realizable Pay for Say-on-Pay Analysis. For several years ISS has calculated and presented a realizable pay metric as part of its qualitative say-on-pay analysis. ISS believes the measure helps show the difference between target bonus/non-equity incentive and what is actually paid in short term programs and for long term programs, the actual payouts and forfeitures as well as the impact of stock price movements.
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ISS Benchmark Survey for Next Season Focuses on Recent Governance Debates – Part I
ISS has launched its benchmark policy survey, which helps formulate policies that guides the proxy advisory firm’s voting recommendations. For the first time, the policy has two parts: a high-level survey covering what it believes to be fundamental and high-profile topics that closes on August 31; and a more expansive version to drill down on key issues that closes on October 6. In addition to the surveys, ISS also seeks input through roundtables and other outreach.
The press release announcing the survey along with the links for downloading and filling it out are here. New policies for the upcoming proxy season are generally issued in November.
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Company Protests ISS Policy on Draft Reports in Vote No Campaigns
Mylan recently publicly protested what may be a little known ISS policy that impacts the provision of draft reports to S&P 500 companies.
CalSTRS, the New York City Comptroller’s office, the New York State Comptroller’s office and PGGM jointly launched a campaign asking the company’s investors to withhold support for six of the company’s board candidates up for election and the say-on-pay vote, filing exempt solicitation materials that show up under the company’s Edgar documents.
As a result, according to a letter the company sent to ISS which it made public, ISS determined that the company would not be provided with a draft voting report.
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ISS Updates Executive Compensation and Equity Plan FAQs
As described in our recent memorandum, ISS will be using other financial and operational metrics in addition to TSR in evaluating say-on-pay. In a recently updated FAQ on its executive compensation policies, this is called the Relative Pay and Financial Performance Assessment.
ISS will introduce this assessment for companies in the Russell 3000E beginning with meetings on or after February 1, 2017. The Russell 3000E Index includes the 4,000 largest publicly traded U.S. companies. According to the updated FAQ, a company’s proxy report will include a standardized comparison of CEO pay and a company’s financial and operational performance rankings relative to the ISS-defined peer group.
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