Each year, ISS undertakes an extensive process to update the policies that inform its benchmark proxy voting recommendations. Our commitment is to make this process open and transparent, so that all members of the financial community--including our institutional investor clients and corporate issuers--understand the foundations of our benchmark policies and proxy voting recommendations. Our objective in this process is to address critical emerging corporate governance issues in a way that informs and enhances dialogue among investors, boards, and companies.
Our broad-based policy formulation process collects feedback from a diverse range of market participants through multiple channels: an annual Policy Survey of institutional investors and corporate issuers, roundtables with industry groups, and ongoing feedback during proxy season. ISS' Global Research Policy Board, comprised of our global research heads and subject matter experts, uses this input in forming draft policy updates, the most significant of which are published for an open review and comment period. Policy changes will be effective for shareholder meetings on or after Feb. 1, 2011.
On Oct. 27, ISS released its key draft 2011 proxy voting policies to obtain feedback from institutional investors, corporate issuers, and industry constituents. The comment period ran through Nov. 11 and solicited feedback on 11 updates to ISS' proxy voting policy guidelines in markets worldwide. The U.S. topics covered included "say on pay" frequency and "say on golden parachute" proposals, independent chair proposals from shareholders, director attendance, and authorized capital requests.
Independent Chair Proposals
The draft U.S. policy update regarding independent chair proposals included consideration of compelling company-specific circumstances that challenge the efficacy of appointing an independent chair. The comments suggested that a company's disclosed rationale for maintaining a combined leadership role would not be a meaningful or useful input in determining a vote on these proposals in extenuating circumstances. These comments were consistent with the responses from the investor participants at an ISS policy roundtable in October. In fact, many institutional investors stated that ISS should not change its policy and should continue to evaluate these proposals on a case-by-case basis, taking into account whether the company has a robust counterbalancing governance structure (including an independent lead director with clearly delineated duties) and any problematic performance, governance, or management issues. Based on this feedback, ISS will not be changing its policy on independent chair proposals in 2011.
Management "Say on Pay" Votes
This is a new proxy item required by Dodd-Frank. The Dodd-Frank Act, in addition to requiring management "say on pay" (MSOP) votes on compensation, requires that each proxy for the first annual or other meeting of shareholders occurring after Jan. 21, 2011, also include an advisory vote to determine whether, going forward, the "say on pay" vote by shareholders should occur every one, two, or three years. In line with overall client feedback, ISS is adopting a new policy to recommend a vote FOR annual advisory votes on compensation, which provide the most consistent and clear communication channel for shareholder concerns about companies' executive pay programs.
The MSOP is at its essence a communication vehicle, and communication is most useful when it is received in a consistent and timely manner. ISS supports an annual MSOP vote for many of the same reasons it supports annual director elections rather than a classified board structure: because this frequency provides the highest level of accountability and direct communication by enabling the MSOP vote to correspond to the majority of the information presented in the accompanying proxy statement for the applicable shareholders' meeting. Having MSOP votes every two or three years, covering all actions occurring between the votes, would make it difficult to create the meaningful and coherent communication that the votes are intended to provide. Under triennial elections, for example, a company would not know whether the shareholder vote references the compensation year being discussed or a previous year, making it more difficult to understand the implications of the vote.
Vote on Golden Parachutes
This is a new proxy item required under the Dodd-Frank Act. ISS' policy will be to recommend CASE-BY-CASE on proposals to approve the company's "golden parachute" compensation, consistent with ISS' policies on problematic pay practices related to severance packages. Features that may lead to an AGAINST recommendation include:
- Recently adopted or materially amended agreements that include excise tax gross-up provisions (since prior annual meeting);
- Recently adopted or materially amended agreements that include modified single triggers (since prior annual meeting);
- Single-trigger payments that will happen immediately upon a change in control, including cash payment and such items as the acceleration of performance-based equity despite the failure to achieve performance measures;
- Single-trigger vesting of equity based on a definition of change in control that requires only shareholder approval of the transaction (rather than consummation);
- Potentially excessive severance payments;
- Recent amendments or other changes that may make packages so attractive as to influence merger agreements that may not be in the best interests of shareholders; and
- In the case of a substantial gross-up from preexisting/grandfathered contract: the element that triggered the gross-up (i.e., option mega-grants at a low stock price, unusual or outsized payments in cash or equity made or negotiated prior to the merger); or the company's assertion that a proposed transaction is conditioned on shareholder approval of the golden parachute advisory vote. ISS would view this as problematic from a corporate governance perspective.
In cases where the golden parachute vote is incorporated into a company's MSOP vote, ISS will evaluate the "say on pay" proposal in accordance with these guidelines, which may give higher weight to that component of the overall evaluation. ISS' policy on change-in-control packages has evolved over the past several years in response to client feedback and changes in common practice. ISS' policy, informed by shareholder input, has focused particularly on severance packages that provide inappropriate windfalls and cover certain tax liabilities of executives.
ISS' current policy is to recommend a vote AGAINST or WITHHOLD from individual directors who attend less than 75 percent of the board and committee meetings without a valid excuse, such as illness, service to the nation, work on behalf of the company, or funeral obligations. If the company provides meaningful public or private disclosure explaining the director's absences, ISS will evaluate the information on a CASE-BY-CASE basis, taking into account the following factors:
- Degree to which absences were due to an unavoidable conflict;
- Pattern of absenteeism; and
- Other extraordinary circumstances underlying the director's absence.
The key policy change is to remove the private disclosure option for explaining absences; articulating the reasons that are acceptable; and clarifying the policy application when the company's attendance disclosure does not conform with SEC requirements. In 2011, ISS will generally recommend a vote AGAINST or WITHHOLD from individual directors who attend less than 75 percent of board and applicable committee meetings (with the exception of new nominees). Acceptable reasons for director(s) absences are generally limited to the following:
- Medical issues/illness;
- Family emergencies; and
- If the director's total service was three meetings or less and the director missed only one meeting.
These reasons for director(s) absences will only be considered by ISS if disclosed in the proxy or another SEC filing. If the disclosure is insufficient to determine whether a director attended at least 75 percent of board and committee meetings in aggregate, ISS will generally recommend a vote AGAINST or WITHHOLD from the director. The policy update aligns the application of the policy with best governance and public disclosure practices and is generally supported by the feedback received during ISS' comment period. Directors who do not attend their board and committee meetings cannot be effective representatives of shareholders. Anyone who accepts a nomination to serve as director should be prepared to make attendance at meetings a top priority.
Customarily, boards set schedules for routine board and committee meetings at least a year in advance. Moreover, attending at least 75 percent of the meetings is not an unreasonable standard for directors to meet, as it still allows sufficient leeway for meetings missed due to legitimate reasons. Issuers are encouraged to proactively provide additional explanatory disclosure on poor attendance for the benefit of shareholders in the proxy or another SEC filing.
Shareholder Ability to Act by Written Consent
After a long hiatus, investors have resumed filing proposals requesting shareholders' ability to act by written consent. However, the corporate governance landscape has changed tremendously. ISS acknowledges that a meaningful right to act by written consent is a fundamental right that enables shareholders to take action between annual meetings. However, the potential risk of abuse associated with the right to act by written consent such as bypassing procedural protections, particularly in a hostile situation, may outweigh its benefits to all shareholders in certain circumstances. Due to alternative mechanisms that have evolved for shareholders to express concern (e.g., a majority vote standard in board elections, the right to call a special meeting) and an evolving governance landscape, ISS will be making a more holistic consideration of a company's overall governance practices and takeover defenses when evaluating these proposals.
ISS' current policy is to generally recommend a vote FOR management and shareholder proposals that provide investors with the ability to act by written consent, taking into account the following factors:
- Shareholders' current right to act by written consent;
- Consent threshold;
- The inclusion of exclusionary or prohibitive language;
- Investor ownership structure; and
- Shareholder support of, and management's response to, previous shareholder proposals.
Based on feedback received from both issuers and institutional investors from ISS' policy roundtable in October, ISS will consider, as an additional factor, the company's overall governance practices and takeover defenses (with emphasis on shareholders' ability to call special meetings) in evaluating these proposals. In 2011, ISS will continue to generally recommend a vote FOR management and shareholder proposals seeking to provide shareholders with the ability to act by written consent, after taking into account the factors mentioned above. However, ISS will recommend on a CASE-BY-CASE basis (and may recommend AGAINST) if, in addition to the considerations above, the company has the following provisions:
- An unfettered right for shareholders to call special meetings at a 10 percent threshold;
- A majority vote standard in uncontested director elections;
- No non-shareholder approved pill; and
- An annually elected board.