This memorandum outlines certain considerations for US public companies in preparation for the 2018 annual reporting and proxy season. Part I of this memorandum discusses new developments and practical action items for the 2018 reporting season; Part II sets forth an overview of recent corporate governance and regulatory developments and trends; and Part III includes a brief discussion relating to upcoming regulatory developments and pending rulemaking initiatives.
Part I. New Considerations and Action Items for the 2018 Reporting Season
ISS and Glass Lewis Proxy Voting Guidelines1
Institutional Shareholder Services ("ISS") and Glass, Lewis & Co. ("Glass Lewis") published updates to their proxy voting policies applicable to shareholder meetings held on or after February 1, 2018.
- Gender Pay Gap—ISS will make case-by-case recommendations on shareholder proposals requesting a report on a company's pay data by gender or its policies and goals to reduce any gender pay gap, taking into account: (i) the company’s current policies and disclosure related to both its diversity and inclusion policies and its compensation philosophy and practices; (ii) whether the company has been the subject of recent controversy, litigation or regulatory actions related to gender pay gap issues; and (iii) whether the company’s reporting regarding gender pay gap policies or initiatives is lagging behind its peers.
- Climate Change Risk—ISS will generally recommend voting for resolutions requesting that a company disclose information on the financial, physical or regulatory risks related to the impact of climate change on its operations and investments or on how the company identifies, measures, and manages such risks. ISS will consider: (i) whether the company already provides current, publicly available information on the impact that climate change may have on the company as well as associated company policies and procedures to address related risks and/or opportunities; (ii) the company's level of disclosure compared to industry peers; and (iii) whether there are significant controversies, fines, penalties or litigation associated with the company's climate change-related performance.
Glass Lewis expanded and codified its policy on climate change-related shareholder resolutions, noting that it will generally recommend in favor of resolutions for companies in certain extractive or energy-intensive industries that request climate change scenario analysis.
- Board Diversity—ISS will specifically identify in its reports which boards have no gender diversity; however, it will not make adverse vote recommendations due to a lack of gender diversity.
In 2018, board diversity will be one of many factors Glass Lewis considers when evaluating companies' oversight structures. Beginning in 2019, Glass Lewis will recommend voting against nominating committee chairs (and potentially other committee members) of boards with no female members, absent a sufficient rationale or a disclosed plan to address the lack of board diversity.
- Board Independence—ISS will recommend voting against or withholding from non-independent directors if any of the following circumstances exist: (i) independent directors comprise 50% or less of the board; (ii) the non-independent director serves on the audit, compensation or nominating committee; (iii) the company lacks an audit, compensation or nominating committee so that the full board functions as that committee; or (iv) the company lacks a formal nominating committee, even if the board attests that the independent directors fulfill the functions of such a committee.
Compensation Issues and Board Responsiveness
- Say on Pay—If a company's prior say-on-pay vote received less than 70% support, ISS will take into consideration any additional shareholder engagement disclosure provided by the company when deciding how to recommend on say-on-pay proposals and compensation committee members in the following year. Such disclosure elements may include: (i) the timing and frequency of the company's engagements with major institutional investors; (ii) whether independent directors participated in such engagement in forming its vote recommendation; and (iii) the specific concerns voiced by dissenting shareholders along with the specific and meaningful actions taken to address such concerns in evaluating the board's responsiveness.2 ISS prefers independent director participation as it facilitates candid investor feedback and will be placing more emphasis on feedback the company receives from investors who voted against say-on-pay.
- Responsiveness to Shareholder Votes— ISS will vote case-by-case on members of the compensation committee (or, in exceptional cases, the full board) and the say-on-pay proposal if the board of directors implements an advisory vote on executive compensation on a less frequent basis than the frequency approved by the company's shareholders.
Glass Lewis considers the board to generally have an imperative to respond to shareholder dissent from a proposal at an annual meeting of more than 20% of votes cast, particularly in the case of a compensationrelated or director election proposal.3
- Non-Employee Director ("NED") Pay—ISS will make recommend against board committee members who are responsible for setting or approving NED compensation when a "pattern of excessive NED pay" is identified in two or more consecutive years, absent a compelling rationale or other mitigating factors. While this will not impact voting recommendations in 2018, negative recommendations will be triggered in subsequent years if a pattern of excessive NED pay is identified.
- Pay Ratio—Both ISS and Glass Lewis will display pay ratio data in their research reports and proxy papers, respectively, but the pay ratio will not impact their vote recommendations in 2018.
ISS will recommend against all board nominees, every year, at a company that maintains a long-term poison pill (one with a term greater than one-year) that has not been approved by shareholders. Commitments to put a longterm pill to a vote the following year will no longer be considered a mitigating factor. Boards with 10-year pills not approved by shareholders, which are currently grandfathered from 2009, will no longer be exempt. Short-term pill (those with a term of one year or less) adoptions will continue to be assessed on a case-by-case basis, but ISS will focus more on the rationale for their adoption than on the company’s governance and track record.
Equity Plan Amendments
ISS' updated FAQs4 indicate that ISS will evaluate equity plan amendment proposals on a case-by-case basis. ISS’ recommendation will generally be based on the Equity Plan Scorecard (EPSC) evaluation/score if any of the following apply: (i) the proposal includes a material request for additional shares; (ii) the proposal represents the first time shareholders have had an opportunity to opine on the plan; (iii) the amendments include an extension of the plan’s term; or (iv) the amendments include the addition of full value awards as an award type when the current plan authorizes only option/SAR grants. However, regardless of EPSC score, and if none of the above four scenarios apply, ISS will make a recommendation based on an analysis of whether the overall impact of the amendments is beneficial or contrary to shareholders' interests. In these cases, the EPSC score will be displayed for informational purposes, but it typically will not determine ISS' recommendation.
- Pledging of Company Stock—If a significant level of pledges of company stock by executives or directors raises concerns, ISS may recommend against all members of either a committee that oversees pledging or the full board, as applicable, taking into consideration: (i) the presence of an anti-pledging policy, disclosed in the proxy statement, that prohibits future pledging activity; (ii) the magnitude of aggregate pledged shares in terms of total common shares outstanding, market value and trading volume; (iii) disclosure of progress or lack thereof in reducing the magnitude of aggregate pledged shares over time; and (iv) disclosure in the proxy statement that shares subject to stock ownership and holding requirements do not include pledged company stock.
- US Categorization of Directors—ISS updated its US director categories to harmonize its categorizations across global markets.5
- Dual-Class Structures—Glass Lewis will consider the presence of dual-class share structures in its evaluation of a company’s corporate governance practices, including in the year of its IPO or spin-off. At established companies, it will generally recommend in favor of proposals to eliminate dual-class share structures and against proposals to adopt a new class of common stock.
- Virtual Shareholder Meetings—In 2019, Glass Lewis will begin recommending against members of the governance committee at companies that plan to hold virtual-only shareholder meetings, unless they have provided assurances that shareholders will be afforded the same rights and opportunities to participate as they would at an in-person meeting.
- Director Commitments—When evaluating whether its directorship limits for public company executives (currently two total board memberships) will be applied, Glass Lewis will consider the specific duties and responsibilities of a director’s executive role in addition to the company’s disclosure regarding that director’s time commitments.
- Removal of Shareholder Discretion on Classified Boards—ISS will generally vote against or withhold from the entire board of directors (except new nominees, who should be considered case-by-case) if the company has opted into or failed to opt out of state laws requiring a classified board structure.
- Pay-for-Performance Evaluation—ISS will add “Relative Financial Performance Assessment” (RFPA) to its quantitative screening for 2018; this measure of alignment between CEO pay and company financial performance was first introduced as part of the qualitative evaluation in 2017. RFPA compares the company’s rankings to a peer group selected by ISS with respect to CEO pay and financial performance in specified metrics (depending on industry), in each case measured over three years.6
Pay Ratio Disclosure7
The pay ratio disclosure rule (the "Rule") requires disclosure of how the median pay of a company’s workforce compares to the compensation of its chief executive officer and applies to each of a company’s registration statement, proxy and information statement and annual report that is required to disclose information on executive compensation pursuant to Item 402 of Regulation S-K.8 The Rule is in effect and disclosure will be required in proxy statements or Form 10-Ks filed in 2018.
In September 2017, the SEC and the staff of the Division of Corporation Finance ("Corp Fin") issued interpretive guidance on the Rule9 , (collectively, the “Guidance”), to assist companies in preparing the required disclosure. The Guidance generally provides more flexibility for issuers in their compliance efforts, so long as their approach is reasonable.
While the Guidance should help reduce costs and streamline compliance efforts, preparation of the pay ratio disclosure can be time consuming and expensive, and companies should already be involved in the process of identifying the median employee and calculating annual total compensation. Companies should also prepare for the potential impact of the public dissemination of their pay ratio disclosure. Specifically, companies may have to address employee relations issues and may be subject to broader public and media scrutiny and critiques of the pay ratio number and possibly of the methodology used as well. Companies should: (i) carefully consider the methodologies they employ, as well as how this information will be disclosed in their proxy statement; (ii) be prepared to address questions and critiques; and (iii) consider proactively communicating with shareholders or other stakeholders to address their concerns and mitigate perception risks. Companies may provide supplemental disclosure to offset or explain a particularly skewed pay ratio, but this may not be more prominent than the required pay ratio disclosure.
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1 ISS' 2018 Voting Guidelines can be found here. Glass Lewis’ 2018 Policy Guidelines can be found here. Our alert on ISS' Voting Guidelines can be found here.
2 ISS' revised FAQs, available here, provide additional details on the factors ISS’ review will take into consideration. See question 16.
3 If voting control is held through a dual-class share structure with disproportionate voting and economic rights, Glass Lewis will examine the level of approval or disapproval attributed to unaffiliated shareholders when determining whether board responsiveness is warranted. Where vote results indicate that a majority of unaffiliated shareholders supported a shareholder proposal or opposed a management proposal, it believes the board should demonstrate an appropriate level of responsiveness.
4 The FAQs on compensation policies are available here. The FAQs on equity compensation plans are available here. Note that effective for meetings as of February 1, 2018, ISS made updates to its EPSC evaluations (see questions 35, 37 and 38).
5 Directors will be categorized as Executive Director, Non-Independent Non-Executive Director and Independent Director (replacing Inside Director, Affiliated Outside Director and Outside Director).
6 See ISS' FAQs, available here, for more information (questions 20 and 21).
7 The pay ratio rule can be found here.
8 For more information on the pay ratio rules, see our prior release, available here.
9 This guidance includes (i) an interpretive SEC release9 , (ii) separate guidance on the calculation of pay ratio disclosure, including guidance on the use of statistical sampling to identify the median employee, published by the staff of Corp Fin and (iii) two new Compliance and Disclosure Interpretations ("C&DIs") and a withdrawal of one C&DI. For more information on this guidance, see our prior release, available here.
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