Client Alert

ISS Provides a Roadmap for the 2021 Proxy Season

17 Nov 2020

Institutional Shareholder Services (ISS) has recently provided guidance outlining its approach to proxy voting advice for the 2021 proxy season. ISS adopted updates to its Benchmark Proxy Voting Guidelines (Voting Policy), provided preliminary guidance on the approach that the proxy advisory firm will take when evaluating compensation changes made in response to the COVID-19 pandemic and eliminated the S&P 500 draft review process.

Updates to the ISS Voting Policy

On November 12, 2020, ISS published updates to its Voting Policy. ISS developed these changes after gathering input from institutional investors, companies, and other market constituents through its annual policy development process. The updated policies will generally be applied for shareholder meetings taking place on or after February 1, 2021.

Governance Failures: Material Environmental & Social Risk Oversight Failures

The Voting Policy provides that under extraordinary circumstances, ISS will recommend a vote against or withhold from directors individually, committee members, or the entire board, due to:

  • Material failures of governance, stewardship, risk oversight, or fiduciary responsibilities at the company;
  • Failure to replace management as appropriate; or
  • Egregious actions related to a director’s service on other boards that raise substantial doubt about his or her ability to effectively oversee management and serve the best interests of shareholders at any company.

The Voting Policy provides examples of risk oversight areas, including: (i) bribery; (ii) large or serial fines or sanctions from regulatory bodies; (iii) significant adverse legal judgments or settlement; or (iv) hedging of company stock.

In the policy updates, ISS expanded this list to include “demonstrably poor risk oversight of environmental and social issues, including climate change.”

Board Diversity

The Voting Policy provides that, for companies in the Russell 3000 or S&P 1500 indices, ISS will generally recommend a vote against or withhold from the chair of the nominating committee (or other directors on a case-by-case basis) at companies where there are no women on the company’s board of directors. When ISS announced this policy in 2019, it indicated that 2020 would be a transitional year, so that a company that previously had not had a female director could make a commitment to add one by the following year.

ISS has now revised the Voting Policy to make clear that this policy applies specifically with respect to gender diversity on the board, and ISS removed the references to 2020 as a transitional year. Under the revised policy, the only exception to the adverse vote recommendations for companies with no women on their board will be if the board has temporarily lost its gender diversity. For example, if there was at least one woman on the board at the previous annual meeting, and the board commits to restoring its gender diversity by the next annual meeting, a company could avoid an adverse voting recommendation from ISS.

ISS updated the Voting Policy to include a new policy governing racial and ethnic diversity. This new policy provides that, for companies in the Russell 3000 or S&P 1500 indices, in 2021 ISS research reports will highlight boards with no apparent racial and/or ethnic diversity. Effective for meetings on or after February 1, 2022, ISS will generally recommend a vote against or withhold from the chair of the nominating committee (or other directors on a case-by-case basis) where the board has no apparent racially or ethnically diverse members. An exception will be made if there was racial and/or ethnic diversity on the board at the preceding annual meeting and the board makes a firm commitment to appoint at least one racial and/or ethnic diverse member within one year.

Classification of Directors

In accordance with the Voting Policy, ISS will generally recommend against or withhold from non-independent directors (those directors who fall into the categories of “Executive Directors” and “Non-Independent Non-Executive Directors under ISS’s “Classification of Directors” policy) when:

  • Independent directors comprise 50 percent or less of the board;
  • The non-independent director serves on the audit, compensation, or nominating committee;
  • The company lacks an audit, compensation, or nominating committee so that the full board functions as that committee; or
  • The company lacks a formal nominating committee, even if the board attests that the independent directors fulfill the functions of such a committee.

The updates to the Voting Policy include several changes to ISS’s Classification of Directors policy. The primary change to the Classification of Directors policy is to limit the “Executive Director” classification to only officers, not other employees, such as those on the board as employee representatives. ISS also addressed in the updated Voting Policy situations where director compensation is comparable to compensation paid to the company’s Named Executive Officers. Currently, with respect to the “Non-Independent Non-Executive Directors” classification under the Classification of Directors policy, where the compensation paid to a director is considerable and on par with the compensation paid to the company’s Named Executive Officers pay for multiple years, the director has been classified as non-independent under “Other material relationships with the company” category. To better ensure “data capture and categorization of material relationships,” this factor has now been made explicit in the Classification of Directors policy. The other changes to the Classification of Directors policy are generally to arrange and consolidate the classifications and to simplify the language where possible.

Poison Pills

ISS will generally recommend a vote against or withhold from all director nominees (except new nominees, who are considered on a case-by-case basis) if the company has a poison pill that was not approved by shareholders. ISS will make voting recommendations on a case-by-case basis if the board adopts a poison pill with an initial term of one year or less, depending on the rationale that is disclosed and other factors. ISS will also recommend a vote against or withhold from all director nominees (except new nominees, who are considered on a case-by-case basis) if the board makes a material modification to an existing poison pill without shareholder approval, including an extension, renewal, or lowering of the trigger.

In the updated Voting Policy, ISS will also recommend a vote against or withhold from all director nominees (except new nominees, who are considered on a case-by-case basis) if the poison pill, whether short- or long-term, has a “dead-hand” or “slow-hand” feature. ISS notes that a “dead-hand” feature of a poison pill restricts the board’s ability to redeem or terminate the pill, while a “slow-hand” feature involves a similar redemption restriction that applies only for a period of time (generally 180 days). ISS notes that the adoption of a poison pill with a “dead-hand” or “slow-hand” feature “is unjustifiable from a governance standpoint, as it is explicitly intended to thwart the will of shareholders in situations where they vote to replace the board in order to enable an offer to proceed.”

Board Refreshment (Age/Term Limits)

The Voting Policy provides that ISS will generally vote against management and shareholder proposals seeking to limit the tenure of independent outside directors through mandatory retirement ages. The updates to the Voting Policy establish a separate policy for management proposals and shareholder proposals relating to term limits, as well as an update to the policy for evaluating management and shareholder proposals about age limits.

The new policy titled “Term/Tenure Limits” specifies that ISS will generally recommend a vote on a case-by-case basis on management proposals regarding director term/tenure limits, taking into consideration:

  • The rationale provided for adoption of the term/tenure limit;
  • The robustness of the company’s board evaluation process;
  • Whether the limit is of sufficient length to allow for a broad range of director tenures;
  • Whether the limit would disadvantage independent directors compared to non-independent directors; and
  • Whether the board will impose the limit evenly, and not have the ability to waive it in a discriminatory manner.

In addition, the updated Voting Policy notes that ISS will make vote recommendations on a case-by-case basis on shareholder proposals asking the company to adopt director term/tenure limits, considering:

  • The scope of the proposal; and
  • Evidence of problematic issues at the company combined with, or exacerbated by, a lack of board refreshment.

As updated, the Age Limits policy indicates the ISS will generally recommend a vote against management and shareholder proposals seeking to limit the tenure of independent directors through mandatory retirement ages. Further, ISS will recommend a vote for proposals to remove mandatory age limits.

Advance Notice Requirements for Shareholder Proposals/Nominations

The Voting Policy specifies that ISS makes vote recommendations on a case-by-case basis on advance notice proposals, giving support “to those proposals which allow shareholders to submit proposals/nominations as close to the meeting date as reasonably possible and within the broadest window possible, recognizing the need to allow sufficient notice for company, regulatory, and shareholder review.”

Under the revised Voting Policy, in order for advance notice requirements to be considered reasonable, the company’s deadline for shareholder notice of a proposal/nominations must be no earlier than 120 days prior to the anniversary of the previous year’s meeting and have a submittal window of no shorter than 30 days from the beginning of the notice period. The submittal window is the period under which shareholders must file their proposals/nominations prior to the deadline. Prior to the update, ISS indicated that company’s deadline for shareholder notice must not have been more than 60 days prior to the meeting, with a submittal window of at least 30 days prior to the deadline.

ISS notes that, in recent years, it has become more common for companies to set advance notice provisions that provide for shareholder notice of action 120 days prior to the meeting, allowing for at least a 30-day submittal period. ISS notes that advance notice provisions subject to this policy do not apply to shareholder proposals submitted under SEC Rule 14a-8 or to director nominations submitted under proxy access provisions.

Shareholder Litigation Rights

The Voting Policy has generally provided for a case-by-case analysis of bylaws that impact shareholders’ litigation rights, considering a variety of factors. As updated, the Voting Policy takes a more nuanced approach to these types of provisions, distinguishing among federal securities law matters, Delaware corporate law matters for Delaware corporations, and corporate law matters for other states.

With regard to provisions regarding federal securities law matters, ISS notes that charter and bylaw provisions designating US federal courts as the exclusive forum for cases arising under federal securities law (the Securities Act of 1933), which had previously been held to be impermissible by the Delaware Court of Chancery, were deemed to be facially valid under Delaware law in a March 2020 ruling by the Delaware Supreme Court. The Voting Policy has been updated to include a policy titled “Federal Forum Selection Provisions,” which indicates that ISS will generally recommend to vote for federal forum selection provisions in the charter or bylaws that specify “the district courts of the United States” as the exclusive forum for federal securities law matters, in the absence of serious concerns about corporate governance or board responsiveness to shareholders. ISS indicates that it will recommend a vote against provisions that restrict the forum to a particular federal district court, and that unilateral adoption (without a shareholder vote) of such a provision will generally be considered a one-time failure under the “Unilateral Bylaw/Charter Amendments” policy.

ISS updated the policy titled “Exclusive Forum Provisions for State Law Matters,” which covers forum provisions in the charter or bylaws that restrict a shareholders’ ability to bring derivative lawsuits against the company, for claims arising out of state corporate law, to the courts of a particular state (generally, the company’s state of incorporation). ISS will generally recommend a vote for charter or bylaw provisions that specify courts located within the state of Delaware as the exclusive forum for corporate law matters for Delaware corporations, in the absence of serious concerns about corporate governance or board responsiveness to shareholders. For states other than Delaware, ISS will recommend votes on a case-by-case basis on exclusive forum provisions, taking into consideration:

  • The company’s stated rationale for adopting such a provision;
  • Disclosure of past harm from duplicative shareholder lawsuits in more than one forum;
  • The breadth of application of the charter or bylaw provision, including the types of lawsuits to which it would apply and the definition of key terms; and
  • Governance features such as shareholders’ ability to repeal the provision at a later date (including the vote standard applied when shareholders attempt to amend the charter or bylaws) and their ability to hold directors accountable through annual director elections and a majority vote standard in uncontested elections.

ISS will generally recommend a vote against provisions that specify a state other than the state of incorporation as the exclusive forum for corporate law matters, or that specify a particular local court within the state. Unilateral adoption of such a provision will generally be considered a one-time failure under the “Unilateral Bylaw/Charter Amendments” policy.

Fee-shifting provisions in the charter or bylaws require that a shareholder who sues a company unsuccessfully pay all litigation expenses of the defendant corporation and its directors and officers. ISS updated its “Fee Shifting” policy to specify that ISS will generally recommend a vote against provisions that mandate fee shifting whenever plaintiffs are not completely successful on the merits (i.e., including cases where the plaintiffs are partially successful). Unilateral adoption of a fee-shifting provision will generally be considered an ongoing failure under the “Unilateral Bylaw/Charter Amendments” policy.

Virtual Shareholder Meetings

Recognizing the impact of the COVID-19 pandemic on the ability of companies to hold in-person annual meetings, the Voting Policy has been updated to address virtual shareholder meetings. ISS will generally recommend a vote for management proposals allowing for the convening of shareholder meetings by electronic means, so long as they do not preclude in-person meetings. ISS indicates that companies are encouraged to disclose the circumstances under which virtual-only meetings would be held, and to allow for comparable rights and opportunities for shareholders to participate electronically as they would have during an in-person meeting. ISS will recommend votes on a case-by-case basis on shareholder proposals concerning virtual-only meetings, considering:

  • The scope and rationale of the proposal; and
  • Concerns identified with the company’s prior meeting practices.
Gender, Race/Ethnicity Pay Gaps Shareholder Proposals

ISS updated the Voting Policy to clarify how ISS evaluates a company’s policies and practices compared to its peers. ISS also wanted to highlight that some legal jurisdictions do not allow companies to categorize employees by race and/or ethnicity and that definitions of ethnic and/or racial minorities differ from country to country, so a global racial and/or ethnicity statistic would not necessarily be meaningful or possible to provide.

The policy specified that ISS will consider, on a case-by-case basis, requests for reports on a company’s pay data by gender or race/ethnicity, or a report on a company’s policies and goals to reduce any gender or race/ethnicity pay gaps, taking into account:

  • The company’s current policies and disclosure related to both its diversity and inclusion policies and practices and its compensation philosophy on fair and equitable compensation practices;
  • Whether the company has been the subject of recent controversy, litigation, or regulatory actions related to gender, race, or ethnicity pay gap issues;
  • The company’s disclosure regarding gender, race, or ethnicity pay gap policies or initiatives compared to its industry peers; and
  • Local laws regarding categorization of race and/or ethnicity and definitions of ethnic and/or racial minorities.
Mandatory Arbitration Shareholder Proposals

ISS noted that a number of shareholder proposals on mandatory arbitration were filed in 2019 and 2020, and several of them went to a vote, with one receiving majority support in 2020. The new policy notes that ISS will consider, on a case-by-case, requests for a report on a company’s use of mandatory arbitration on employment-related claims, taking into account:

  • The company’s current policies and practices related to the use of mandatory arbitration agreements on workplace claims;
  • Whether the company has been the subject of recent controversy, litigation, or regulatory actions related to the use of mandatory arbitration agreements on workplace claims; and
  • The company’s disclosure of its policies and practices related to the use of mandatory arbitration agreements compared to its peers.
Sexual Harassment Shareholder Proposals

ISS notes that a number of shareholder proposals were filed on the issue of sexual harassment in 2019 and 2020, with several going to a vote. ISS will consider, on a case-by-case basis, proposals requesting a report on company actions taken to strengthen policies and oversight to prevent workplace sexual harassment, or a report on risks posed by a company’s failure to prevent workplace sexual harassment, taking into account:

  • The company’s current policies, practices, oversight mechanisms related to preventing workplace sexual harassment;
  • Whether the company has been the subject of recent controversy, litigation, or regulatory actions related to workplace sexual harassment issues; and
  • The company’s disclosure regarding workplace sexual harassment policies or initiatives compared to its industry peers.
COVID-19: ISS Provides Preliminary Guidance for the 2021 Proxy Season

ISS recently published U.S. Compensation Policies and the COVID-19 Pandemic Frequently Asked Questions (FAQs), which discuss the approach that ISS will take on a variety of executive compensation issues arising from the COVID-19 pandemic when determining voting recommendations for the 2021 annual meetings of U.S. public companies. While the guidance is preliminary and may evolve over time, the FAQs provide important insights as companies and their boards of directors consider compensation changes and related disclosures for the 2021 proxy season.

ISS indicates that its pay-for-performance qualitative evaluation will take into account the impact of the COVID-19 pandemic on the operations of companies. Consistent with past practice, if ISS determines that it has an elevated level of concern about a company by applying the quantitative screen, then ISS will conduct an in-depth qualitative review of that company’s compensation programs and practices.

Salary

ISS indicates that temporary salary reductions will be given mitigating weight to the extent they decrease total pay, given that base salaries typically make up a small portion of total pay for executive officers. ISS notes that a salary reduction will be considered “more meaningful” in a situation where the targeted incentive payout opportunities are decreased to reflect the salary reduction.

Bonus and Annual Incentive Programs

ISS notes that changes to bonus and annual incentive programs arising from the COVID-19 pandemic could include:

  • Changes to metrics, performance targets, and measurement periods;
  • Suspension of bonus and annual incentive programs, with a shift to discretionary payments; and
  • A combination of these approaches.

Absent the COVID-19 pandemic, ISS would generally view these types of changes to bonus and annual incentive programs in negative light when evaluating the pay-for-performance profile of a company.

The FAQs indicate that, given the “extraordinary circumstances of the current economic downturn,” ISS may view such actions “to be a reasonable response so long as the justifications and rationale are clearly disclosed, and the resulting outcomes appear reasonable.”

ISS indicates that the investors expect to see the following disclosures so that they can evaluate changes to annual bonus and incentive programs arising from the COVID-19 pandemic:

  • The specific challenges that were incurred as a result of the COVID-19 pandemic, and how those challenges “rendered the original program design obsolete or the original performance targets impossible to achieve,” as well as disclosure indicating that the changes are not reflective of poor management performance;
  • For mid-year changes versus one-time discretionary awards, an explanation as to why that approach was taken instead of the alternative approach and how the change furthers the interests of investors;
  • Specific information about performance-based considerations for one-time discretionary awards, including the underlying criteria that has been applied;
  • A discussion of how the resulting payouts “appropriately reflect both executive and company annual performance,” clarifying or estimating how the resulting payouts compare with what would have been paid under the original program design (in particular addressing above-target payouts under changed programs); and
  • For those companies that have designed their 2021 annual incentive program at the time the disclosure is made, a discussion of any positive changes that could carry mitigating weight in the qualitative evaluation.

In those situations where changes to a company’s bonus or annual incentive programs result in a lowering of financial or operational targets below prior year levels, ISS expects to see disclosure of “how the board considered corresponding payout opportunities, particularly if such payout opportunities are not commensurately reduced.” ISS notes that investors have indicated lower performance expectations reflecting operational impacts due to the pandemic may be a reasonable explanation for lowering financial or operational targets.

Long-Term Incentive Programs

The FAQs indicate that ISS will take the following approaches:

  • In-Progress Incentive Cycles - ISS will generally view any changes as a result of the COVID-19 pandemic negatively, based on the view that long term incentive arrangements “should be designed to smooth performance over a long-term period and not be altered after the beginning of the cycle based on a short-term market shock;” and
  • Incentive Cycles Beginning in 2020 - ISS indicates that investors “generally do not expect to see drastic changes to the long-term incentive program unless the underlying business strategy has fundamentally changed;” however, more modest alterations to the incentive program, such as a transition to relative or qualitative metrics when long-term financial forecasts cannot be produced, could be viewed as reasonable.
One-Time Awards

ISS recognizes that some companies may grant one-time awards as a result of the COVID-19 pandemic, which may include one-time awards for the purpose of retaining executives.

ISS indicates that companies granting one-time awards “should clearly disclose the rationale for the award (including magnitude and structure), as well as describe how the award furthers investors’ interests,” and should avoid boilerplate references to “retention concerns.”

Overall, ISS expects that one-time awards arising from the COVID-19 pandemic:

  • Are reasonable in magnitude and represent an isolated practice;
  • Include vesting conditions that are strongly performance-based and tailored to address the underlying concerns arising from the COVID-19 pandemic, with a long-term vesting schedule; and
  • Contain “shareholder-friendly guardrails to avoid windfall scenarios, including limitations on termination-related vesting.”

In the FAQs, ISS indicates that “investors do not expect companies to grant such awards merely as a replacement for forfeited performance-based awards.”

ISS expects companies to explain the specific issues driving the decision to grant the awards and how the awards further investors’ interests when one-time awards are granted in the year (or following year) in which incentives are forfeited. If the explanation indicates that one-time awards “were granted in consideration of forfeited incentives, for fairness considerations, lowered realizable pay, etc.,” ISS expects an explanation of how the one-time awards “do not merely insulate executives from lower pay.”

Responsiveness Policy

If a company receives less than 70 percent support on its say-on-pay proposal, ISS reviews three factors:

  • The disclosure of the board’s shareholder engagement efforts;
  • The disclosure of the specific feedback received from dissenting investors; and
  • Actions or changes made to pay programs and practices to address investors’ concerns.

In the FAQs, ISS indicates that it will still consider the first two factors in line with prior practice. With regard to the third factor, ISS notes that if a company is unable to implement changes due to the COVID-19 pandemic, “the proxy statement should disclose specifically how the pandemic has impeded the company’s ability to address shareholders’ concerns.” If changes to a company’s compensation program are delayed, or do not fully address the feedback the company received from investors, ISS expects the company to disclose its longer-term plan as to how investors’ concerns will be addressed.

Changes to the Equity Plan Scorecard (EPSC), Problematic Pay Practices (PPP) or Option Repricing Policies  

The FAQs indicate that ISS will not make any changes to its EPSC, PPP or Option Repricing policies as a result of the COVID-19 pandemic.

Elimination of the S&P 500 Draft Review Process for 2021

ISS has changed its approach to providing draft proxy research reports to companies in the S&P 500 index prior to publication of such reports. For shareholder meetings on or after January 1, 2021, ISS will no longer provide draft reports to U.S. companies within the S&P 500. ISS has determined to make this change because it believe that the S&P 500 draft review process is no longer necessary, and it is not being used by many companies as intended.

ISS notes that all companies can still access copies of the final ISS report, at no cost. ISS indicates that companies may still provide feedback to ISS after the final report has been issued. If relevant new information comes to light or any errors in a report are identified, ISS may use its “Alert:” process to update a previously issued report where an update is warranted.

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