Written by Karen Keck, Jon C. Truswell and Elyse P. van Spronsen
Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis) have both released updates to their respective Canadian proxy voting guidelines for the upcoming 2016 proxy season. The ISS updates will apply to shareholder meetings of publicly traded Canadian companies occurring on or after February 1, 2016, while Glass Lewis updates will apply to meetings that are held on or after January 1, 2016.
Recommendations from proxy advisory firms such as ISS and Glass Lewis can have a significant impact on the outcome of business conducted at shareholder meetings, especially if institutional investors comprise a significant component of the shareholder base. Canadian public companies should review the updates with their legal counsel to determine the likely impact and take steps to mitigate any potential adverse voting recommendations from ISS or Glass Lewis.
Key Updates to ISS Proxy Voting Guidelines
Director Overboarding – TSX Listed Issuers
"Generally vote withhold for any individual director nominee if, irrespective of whether the company has adopted a majority voting policy, the director is overboarded and has attended less than 75 percent of his or her respective board and committee meetings held in the past year without a valid reason for these absences."
ISS proxy voting guidelines for the 2015 proxy season consider a director to be "overboarded" if he or she: (i) is a CEO of a public company and sits on more than two (2) outside public company boards in addition to the company of which he or she is CEO; or (ii) is not a CEO of a public company and sits on more than six (6) public company boards in total.
The 2016 ISS updates impose tighter restrictions on overboarding for TSX-listed issuers. In the case of CEO's, the number of outside public company boards has been changed from two (2) to one (1) and, in the case of non-CEO's, the number of public company boards has changed from six (6) to four (4). In order to afford affected directors and companies time to make orderly changes to board commitments, this change will be implemented starting on February 1, 2017.
Equity Plan Scorecard (EPSC) for Equity Compensation Plans – TSX Listed Issuers
"Vote case-by-case on equity-based compensation plans using an "equity plan scorecard" (EPSC) approach."
The 2016 ISS updates will replace the pass/fail tests imposed by ISS during the 2015 proxy season with a scorecard that is used to consider a range of positive and negative factors to evaluate TSX equity-based compensation plans. The factors are grouped into three pillars, which are described as follows:
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 (SVT) in relation to its peers and considering both:
Absence of problematic change-in-control (CIC) provisions, including:
No financial assistance to plan participants for the exercise or settlement of awards.
Public disclosure of the full text of the plan document.
Reasonable share dilution from equity plans relative to market best practices.
Reasonable three-year average burn rate relative to market best practices.
Meaningful time vesting requirements for the CEO's most recent equity grants (three-year lookback).
The issuance of performance-based equity to the CEO.
A clawback provision applicable to equity awards.
Post-exercise or post-settlement share-holding requirements (S&P/TSX Composite Index only).
To make a voting recommendation, ISS will assess all of these factors in combination. ISS will only recommend a vote against a plan if the combination of the above factors, as determined by an overall score, indicates that the plan is not in the shareholders' interest. Assessing these factors in combination facilitates a more holistic approach to voting recommendations. As a result, certain plans may receive a favourable recommendation even though they contain features that would not have passed the pass/fail tests imposed by ISS last year. For example, a plan where cost is nominally higher than the allowable cap may receive a favourable recommendation if sufficient positive factors are present.
However, ISS will continue to automatically recommend voting against any plan that: (i) allows for discretionary or insufficiently limited non-employee director participation; (ii) contains an amendment provision which fails to adequately restrict the company's ability to amend the plan without shareholder approval; (iii) has a history of repricing stock options without shareholder approval (three-year look back); (iv) is a vehicle for problematic pay practices or a significant pay-for-performance disconnect; or (v) has any other features that are determined to have a significant negative impact on shareholder interests.
The scorecards will differ for S&P/TSX Composite Index versus the Non-Composite TSX-listed Issuers. ISS will also use "Special Cases" versions of these scorecards where certain historic data is unavailable.
Weightings for the three pillars applicable to the S&P/TSX Composite Index will be: (i) 40 percent for plan costs; (ii) 20 percent for plan features; and (iii) 40 percent for grant practices. Additional information about this 2016 ISS update and the weightings will be published by ISS in December.
Compensation-Related Votes at Externally Managed Issuers – TSX and TSXV Listed Issuers
"Vote case-by-case on say-on-pay resolutions where provided, or on individual directors, committee members or the entire board as appropriate, of an externally-managed issuer that has provided minimal or no disclosure about its management services agreement and how senior management is compensated."
Externally-managed issuers (EMIs) typically do not disclose details about their management services agreements in their proxy statements and only provide disclosure on the aggregate amount of fees paid to the manager, with minimal or incomplete compensation information.
Under the 2016 ISS updates, ISS has developed a framework to hold EMI boards accountable for the compensation practices of EMIs. ISS plans to make voting recommendations on say-on-pay resolutions of an EMI or, if an EMI does not have a say-on-pay resolution, on individual directors, committee members or the entire board of an EMI, which provides minimal or no disclosure about its management services agreement and how senior management is compensated. To make such voting recommendations, ISS will consider a number of factors including: (i) size and scope of the management services agreement; (ii) executive compensation in comparison to issuer peers or similarly structured issuers; (iii) overall performance; (iv) related party transactions; (v) board and committee independence; (vi) conflicts of interest and the process for managing conflicts effectively; (vii) disclosure and independence of the decision-making process involved in the selection of the management services provider; (viii) risk mitigating factors included within the management services agreement such as fee recoupment mechanisms; (ix) historical compensation concerns; (x) executives' responsibilities; and (xi) other factors that may be reasonably deemed appropriate to assess an EMI's governance framework.
Because advisory votes on compensation are voluntary in Canada (and none of the currently identified EMIs conducted say-on-pay votes in the past year), the effect of this 2016 ISS update will more likely be evident in recommendations on the election of directors of EMIs.
Key Updates to Glass Lewis Proxy Paper Guidelines
Environmental and Social Risk Oversight – TSX and TSXV Listed Issuers
"In cases where the board or management has failed to sufficiently identify and manage a material environmental or social risk that could negatively impact shareholder value, vote withhold for any directors responsible for risk oversight in consideration of the nature of the risk and potential effect on shareholder value."
Glass Lewis is of the view that management should complete a risk analysis of company operations, including those with environmental and social implications and that directors should monitor management's performance in managing and mitigation these environmental and social risks to minimize the risks to the company and its shareholders. Where the board or management has failed to sufficiently identify and manage a material environmental or social risk that did or could negatively impact shareholder value, Glass Lewis will recommend a withhold vote against the directors responsible for risk oversight.
Proxy Access – TSX and TSXV Listed Issuers
"Glass Lewis reviews proposals requesting proxy access on a case-by-case basis, but generally supports shareholders' ability to nominate director candidates to management's proxy as a means to ensure that significant, long-term shareholders have an ability to nominate candidates to the board."
Shareholder proposals seeking proxy access or unprompted company-led proxy access proposals will be considered by Glass Lewis taking into account several factors, including: (i) company size; (ii) board independence and diversity of skills, experience, background and tenure; (iii) the shareholder proponent and the rationale for putting forth the proposal at the target company; (iv) the percentage ownership requested and holding period requirement; (v) shareholder base in both percentage of ownership and type of shareholder (e.g., hedge fund, activist investor, mutual fund, pension fund, etc.); (vi) responsiveness of board and management to shareholders evidenced by progressive shareholder rights policies (e.g., majority voting, declassifying boards, etc.) and reaction to shareholder proposals; (vii) company performance and steps taken to improve poor performance (e.g., new executives/directors, spin-offs, etc.); (viii) existence of anti-takeover protections or other entrenchment devices; and (ix) opportunities for shareholder action (e.g., ability to act by written consent or right to call a special meeting).
Exclusive Forum Provisions – TSX and TSXV Listed Issuers
"Recommend voting against any bylaw or charter amendments seeking to adopt an exclusive form provision unless the company: (i) provides a compelling argument on why the provision would directly benefit shareholders; (ii) provides evidence of abuse of legal process in other, non-favored jurisdictions; (iii) narrowly tailors such provision to the risks involved; and (iv) maintains a strong record of good corporate governance practices."
The 2016 Glass Lewis updates clarify that Glass Lewis generally considers exclusive form provisions to be against shareholder interests as such provisions limit a shareholder's choice of legal venue and may increase associated costs of shareholder claims or make legal recourse more difficult to pursue. However, Glass Lewis acknowledges that a company may be subject to frivolous and opportunistic lawsuits, particularly in a merger or acquisition context, and recognizes the need for companies to minimize these distracting and often costly suits by adopting bylaws regarding, inter alia, where the suits must be brought.
Where an exclusive form proposal is bundled into a bylaw amendment, Glass Lewis will weigh the importance of the other bundled provisions when determining a vote recommendation on the proposal.
Director Overboarding Policy – TSX Listed Issuers
"Typically recommend voting withhold for a director who serves as an executive officer of any public company while serving on a total of more than three public company board (i.e., their own company's board and two others), and any other director who serves on a total of more than six public company boards."
Similar to ISS, Glass Lewis has announced tighter rules for director overboarding. Beginning in 2017, the number of public company boards for executives will be reduced from three to two and, for non-executives, the number of public company boards will reduced from six to five. During 2016, Glass Lewis may note as a concern instances where directors do not meet the 2017 requirements. Directors at TSXV listed companies will generally continue to be permitted to serve on up to nine public company boards.
Audit Committee Over-Commitment – TSXV Listed Issuers
"Recommend voting withhold for an audit committee member who sit on an excessive number of public company audit committees."
Beginning in 2016, for TSXV listed issues, Glass Lewis has increased the number of audit committee memberships for TSXV listed issuers from three to four, with an extended limit of five committee memberships for members with financial experience. In making a voting recommendation, Glass Lewis will consider company size, geographic distribution and the member's level of expertise and overall commitments, with recommendations ultimately made on a case-by-case basis.
Nominating Committee Performance – TSX and TSXV Listed Issuers
"May recommend voting withhold for the chair of a nominating and governance committee where the board's failure to ensure that that board has directors with relevant experience, either through periodic assessment or board refreshment, has contributed to a company's poor performance."
Glass Lewis is of the view that boards should have diverse backgrounds and members with a breadth and depth of relevant experience, and that nominating and governance committees should consider diversity when making director nominations. Glass Lewis believes that shareholders are best served when boards make an effort to ensure a constituency that is not only reasonably diverse on the basis of age, race, gender and ethnicity, but also on the basis of geographic knowledge, industry experience, board tenure and culture.
Glass Lewis has revised its nominating and governance committee performance recommendations to clarify that it may recommend a withhold vote against the chair of the nominating committee where the board's failure to ensure that individual board members possess relevant experience, either through periodic director assessment or board refreshment, has contributed to the company's poor performance.
Director Quorum Requirements – TSX and TSXV Listed Issuers
"Glass Lewis looks for a requisite quorum of a majority of the directors of the board."
Glass Lewis has clarified its guidelines to indicate that it will require a requisite quorum of a majority of the directors of a board when assessing the adoption of amendments to a company's charter or bylaws.
Bennett Jones is able to assist clients in reviewing the updated voting guidelines to determine the likely impact of the voting recommendations from ISS and Glass Lewis. The respective policy updates may be viewed in full at ISS and Glass Lewis.