The Perfect Enemy | ISS issues benchmark policy updates for 2023 | Cooley LLP
February 8, 2023
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At the end of last week, ISS announced its benchmark policy updates for 2023. The policy changes will apply to shareholder meetings held on or after February 1, 2023, except for those with one-year transition periods.  The changes for U.S. companies relate to policies regarding, among other things, unequal voting rights, problematic governance structures, board gender diversity, exculpation of officers, poison pills, quorum requirements, racial equity audits, shareholder proposals on alignment between public commitments and political spending and board accountability for climate among the Climate Action 100+. The results are based in part on the results of ISS’s global benchmark surveys (see this PubCo post) as well as a series of roundtables.

Unequal voting rights. In 2015, ISS adopted a policy to vote against directors of newly public companies that retained certain governance provisions that ISS disapproved, including multi-class capital structures with unequal voting rights (in the absence of a reasonable sunset of no more than seven years), classified boards and companies with supermajority vote requirements to amend governing documents.   Notably, however, ISS grandfathered companies that already had these provisions.  In the 2021 benchmark policy survey, among investors, 94% advocated that ISS revisit the grandfathering policy, and 57% of non-investors had the same view. Accordingly, in 2021, ISS removed the policy differential that arose out of that grandfathering, but allowed companies a one-year grace period in 2022. Under the new policy (which reflects the expiration of the grace period), beginning with meetings on and after February 1, 2023, ISS will generally recommend a withhold or against vote for directors individually, committee members or the entire board (except new nominees, who would be considered on a case-by-case basis), if the company has a common stock structure with unequal voting rights, including classes of common stock that have additional votes per share, classes of shares that are not entitled to vote on all the same ballot items or nominees, or stock with time-phased voting rights. There would be some exceptions, including for newly public companies that have a sunset provision of no more than seven years from the date of going public, limited partnerships and REITs, circumstances where the super-voting shares are considered de minimis, or where the “company provides sufficient protections for minority shareholders, such as allowing minority shareholders a regular binding vote on whether the capital structure should be maintained.” The policy update defines the level of voting power for super-voting shares that would be considered de minimis as less than 5% of total voting power.  ISS has previously observed that the new policy means that “starting in 2023, ISS will likely be recommending against directors at many large or iconic U.S. companies that have unequal voting rights structures.”

Problematic governance structures.   With regard to other problematic governance structures (such as classified boards or supermajority vote requirements) at newly public companies, ISS views the inclusion of a reasonable sunset provision as a mitigating factor.  In the benchmark survey, ISS asked respondents about the duration of a reasonable time period.  Between three and seven years was the time period selected by 43% of investor respondents and 37% of non-investors. Under the new policy update, a “reasonable sunset period” to fully eliminate the provision is defined as no more than seven years from the date of going public. That time period also aligns with current ISS benchmark policy regarding the sunset period for problematic capital structures. The policy language was also updated to explicitly state that a “newly public company” is meant to be a company that holds or held its first annual meeting of public shareholders after February 1, 2015.

Board gender diversity. Currently, for a company in the Russell 3000 or S&P 1500, ISS policy is generally to 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 (except when there was a woman on the board at the preceding annual meeting and the board makes a firm commitment to return to a gender-diverse status within a year). Last year, ISS expanded the application of that policy to companies beyond the Russell 3000 and S&P 1500, to apply after a one-year grace period, for meetings on or after February 1, 2023. Accordingly, the language regarding the transition will be eliminated.  In addition, the diversity policy for FPIs previously applicable only to FPIs in the Russell 3000 and S&P 1500 will also be expanded to all FPIs in 2023.

Exculpation of officers.  In August, an amendment to Delaware law became effective that allowed companies to adopt charter provisions that would eliminate the personal liability of specified officers for breaches of the duty of care—basically, an analog of DGCL Section 102(b)(7). The exculpatory provision for officers would have the same exclusions as the provision for directors—breach of the duty of loyalty, acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, or any transaction from which the officer derived an improper personal benefit—with one significant addition: exculpation would not be permitted for any action by or in the right of the corporation, i.e., derivative claims. Accordingly, the amendment would afford protection for claims for breach of the duty of care brought directly against officers by stockholders, but claims in which officers are alleged to have breached the duty of care could still be made by the board in the name of the corporation and by stockholders on a derivative basis. (See this PubCo post.)  Under the new policy, where a company proposes to amend its charter to provide for officer exculpation provisions, ISS will make its recommendations on a case-by-case basis, considering a number of factors, including the stated rationale for the change.

Poison pills. ISS generally recommends votes on a case-by-case basis on board nominees in connection with the adoption of short-term poison pills (with a term of one year or less) without a shareholder vote, taking into account a number of factors. The update clarifies that one additional factor that will be a consideration is the ownership level at which the the short-term pill is triggered. ISS observed that

“[d]uring the initial phase of the COVID-19 pandemic in 2020, with the severe market turbulence, many companies adopted short-term poison pills. Many of these featured very low triggers—10 percent or even 5 percent—implying that the objective of a poison pill has morphed over time from defense against a hostile takeover, to defense against an activist campaign that may or may not contemplate a change in control. Shareholders have a clear interest in preventing an opportunistic takeover at a price that does not reflect the company’s long-term fair value, due to factors such as short-term market disruptions. However, this must be balanced against the potential for an inordinately low trigger to entrench an underperforming board and management team by insulating them shareholders who may be seeking operational or strategic changes that could enhance value, or governance changes that could benefit all shareholders.”

Unilateral bylaw or charter amendments. Generally, if the board amends the company’s bylaws or charter without shareholder approval and the amendment materially diminishes shareholders’ rights or may adversely impact shareholders, ISS will consider a number of factors to determine whether to recommend votes against directors.  ISS generally recommends votes against directors (except new nominees, who are considered on a case-by-case basis) if the board takes certain actions, such as adopting supermajority vote requirements to amend the bylaws or charter.  The new policy update adds to that list unilateral adoption of a fee-shifting provision or another provision deemed egregious. Fee-shifting provisions require a shareholder who sues a company unsuccessfully to pay all litigation expenses of the defendant corporation and its directors and officers. This update explicitly includes fee shifting “for completeness and clarity. If other egregious unilateral adoptions are identified, they too may result in ongoing recommendations against director nominees.”

Board accountability on climate. For 2023, companies that are considered “significant GHG emitters” (defined as those in the Climate 100+ Focus Group), ISS is extending the framework for all applicable markets and updating its policy: where a significant GHG emitter is not providing adequate disclosure, such as disclosure consistent with the TCFD (Task Force on Climate-related Financial Disclosures) framework, and “does not have either medium-term GHG emission reductions targets or Net Zero-by-2050 GHG reduction targets for at least a company’s operations (Scope 1) and electricity use (Scope 2),” ISS will generally recommend voting against the appropriate directors.  The update states that emission reduction targets should also cover the vast majority (95%) of the company’s operational (Scopes 1 and 2) emissions.  ISS will differentiate implementation of any negative vote recommendations depending on relevant market and company factors.

In its benchmark policy survey, ISS asked, with regard to “significant GHG emitters,” what types of actions should be considered indicative of a “material governance failure”—leading to an ISS vote recommendation against directors.  (See this PubCo post.) According to the survey, 86% of investor respondents and 60% of non-investor respondents expected companies to provide climate change risk disclosure and to take action.   Likewise, a significant majority of respondents viewed a company that is a significant contributor but is “not providing adequate disclosure with regards to climate-related oversight, strategy, risks and targets according to a framework such [as] the one developed by the Task Force on Climate-related Financial Disclosures (TCFD)” to be demonstrating a material governance failure. 

Investor respondents to the ISS survey viewed the boards of companies that were large GHG emitters to be “failing” if they were not taking steps to address emissions, although there were differences of opinion on what steps to take. Following inadequate disclosure, the three most common “failures” identified by investor respondents were targets-related, including “(i) a company not setting realistic medium-term targets (through 2035) for Scope 1 & 2 only (50% of investors), (ii) not declaring a net-zero by 2050 ambition (47% of investors), and (iii) not setting realistic medium-term targets (through 2035) for Scope 1, 2 & 3 if Scope 3 is relevant (45% of investors).” “Realistic” targets are targets that “do not overly rely on technologies that are not yet commercially available and are not overly reliant on offsets.”

Amendments to quorum requirements. Generally, ISS has recommended against proposals to reduce quorum requirements.  Under the update, ISS will now make recommendations on a case-by-case basis, taking into consideration a number of factors, such as the new quorum threshold requested, the company’s market capitalization and ownership structure, previous voter turnout or attempts to achieve quorum and the rationale for the reduction. Over the past two years, ISS has observed that more small companies, especially those with large retail ownership, “have had to adjourn their meetings, often repeatedly, due to the lack of a quorum. Eventually, many of them have unilaterally reduced the quorum requirements to less than 50% and were then able to hold the meeting.” ISS attributes the problem in achieving quorum to “the decision by certain large brokerage firms to no longer provide discretionary or proportionate broker voting,” together with the reduction in the scope of items that are deemed “routine” and therefore can be voted on by brokers even without client voting instructions.

Racial equity audits. ISS recommends votes on a case-by-case basis with regard to proposals for racial equity or civil rights audits.  In light of the recent increase in investor support for these audits, ISS is updating its policy criteria for the case-by-case analysis of these proposals to include the adequacy of the company’s disclosure of its workforce diversity-and-inclusion metrics and goals to facilitate quantitative assessments of progress. In addition, ISS is eliminating as a factor explicit alignment with market norms “as it has not in practice been an analysis driver for this type of proposal.”

ESG compensation-related proposals. Current ISS policy on proposals related to ESG and compensation is “to generally recommend voting against shareholder proposals seeking to set absolute levels on compensation or otherwise dictate the amount or form of compensation (such as types of compensation elements or metrics) to be used in incentive pay programs.” In the update, ISS “clarifies that the policy considers the company’s board or compensation committee is generally in the best position to determine the performance metrics, whether they are financial or ESG specific, while affirming that improved disclosure about the committee’s rationale and considerations of pay metrics (including those for ESG topics) may benefit shareholders.” For example, the update adds as a factor to be considered in the analysis the “degree to which the board or compensation committee already discloses information on whether it has considered related E&S criteria.”

Shareholder proposals on transparency regarding alignment between public commitments and political spending.  ISS is introducing a new policy for shareholder proposals requesting company transparency on alignment of its political contributions, lobbying and election spending with its public commitments, stated values and policies, such as the alignment between climate lobbying and expressed climate goals. ISS notes that the number of these proposals has recently been increasing. The new policy will provide more transparency to the market about how these shareholder proposals are assessed and codify the case-by-case approach used in the 2022 proxy season. Under the new policy, ISS will generally vote on a case-by-case basis on these proposals taking into account

  • “The company’s policies, management, board oversight, governance processes, and level of disclosure related to direct political contributions, lobbying activities, and payments to trade associations, political action committees, or other groups that may be used for political purposes;
  • The company’s disclosure regarding: the reasons for its support of candidates for public offices; the reasons for support of and participation in trade associations or other groups that may make political contributions; and other political activities;
  • Any incongruencies identified between a company’s direct and indirect political expenditures and its publicly stated values and priorities.
  • Recent significant controversies related to the company’s direct and indirect lobbying, political contributions, or political activities. Generally vote case-by-case on proposals requesting comparison of a company’s political spending to objectives that can mitigate material risks for the company, such as limiting global warming.”

Share issuance mandates. For U.S. domestic issuers incorporated outside the U.S. and listed solely on a U.S. exchange, ISS is introducing a new policy “to generally vote for resolutions to authorize the issuance of common shares up to 20 percent of currently issued common share capital, where not tied to a specific transaction or financing proposal. The creation of a specific policy on this topic for U.S.-listed but non-U.S. incorporated companies is intended to better reflect the expectations and concerns of investors in the U.S. market. The policy will apply to companies with a sole listing in the U.S., but which are required by the laws of the country of incorporation to seek approval for such share issuances. Dual-listed companies that are required to comply with listing rules in the country of incorporation will continue to be evaluated under the policy for that market.”

ISS is also making changes in some other policies, including problematic pay practices—where the update codifies ISS’ current approach to evaluating severance payments received by an executive when the termination is not clearly disclosed as involuntary, as described in ISS’ U.S. Compensation Policies FAQ document—and value-adjusted burn rate—where the update eliminates the reference to the transition period for the use of the VABR methodology. The updates also tweak the policy regarding E&S shareholder proposals, codifying the current approach to take into account whether or not regulation or legislation is likely to occur and to clarify that ISS considers as a factor whether there are significant controversies associated with the company’s practices but only to the extent they are related to the issue raised in the proposal.

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