Each year, Institutional Shareholder Services (“ISS”) releases its policy updates and voting guidelines for the year (and proxy season) ahead. As companies think about preparing their boards, operations and disclosures for 2021, it will be important to review the underlying drivers of ISS’ policy changes in context, reflecting a significant year, both from the perspective of the broader macroenvironment faced by all stakeholders, as well as the regulatory changes imposed by the Securities and Exchange Commission (“SEC”) and applicable to ISS and other proxy advisors.
See our blog posts for an overview of ISS’ 2021 updates, the SEC proxy advisor regulations and compensation-related considerations for the 2021 proxy season.
The Recovery Period and the Harsh Light of 20/20 Hindsight
The initial stage of the pandemic increased market volatility and tested companies’ crisis response plans in Q1, just as companies were preparing for and holding their annual shareholder meetings. In attempting to shore up protections against volatility and adapt to rapidly changing market conditions, a number of companies prophylactically adopted short-term poison pills, switched to virtual shareholder meetings, cut dividends, withdrew guidance, revised executive pay off-cycle and authorized financing. Investors and proxy advisory firms displayed a degree of leniency with companies navigating a challenging business environment. As the months passed, however, it is evident that leniency is not a “free pass,” and companies should not confuse leniency with tolerance or acceptance, particularly as businesses enter the recovery era.
Some companies have already begun to feel the limits of leniency, as an S&P 500 company that adopted a pill with a 5% trigger discovered when its chair received an adverse recommendation from ISS at the 2020 annual shareholder meeting (and received only 66.22% shareholder support, while other directors received 89%+ shareholder support), and the pill was challenged in Delaware Chancery Court. In its 2021 policy updates, ISS put companies on notice that deadhand and slowhand provisions, designed to prevent changes or redemption of a pill in the future, will draw ISS scrutiny, up to and including a recommendation of withhold votes against directors who approved the pill.
The policy itself is perhaps not a surprise to those who have followed ISS’ wary acceptance of short-term pills. However, there is little a board can do to fix the problem once adopted; the redemption or expiration of a pill with a deadhand or slowhand provision will not save a director, nor is it expected that any justification will absolve a board from ISS’ scrutiny. ISS believes that the unilateral adoption of short-term pills with these features is a material governance failure—one that exists “even if the pill itself has expired by the time of that meeting.” [1]
Investing in Social Change
Director Racial and Ethnic Diversity
2020 saw an explosive global social movement on racial injustice, which propelled the fight for racial equality in the United States. This movement was not lost on corporate stakeholders. In ISS’ 2020-2021 Global Policy Survey, almost 60% of investors indicated that boards should reflect the broader society and a company’s customer base and 57% of investors responded that they would consider voting against members of the nominating committee or other directors if a board lacked racial and ethnic diversity. ISS has now adopted policies for racial and ethnic board diversity that mirror the minimum standards required with respect to gender diversity in the last few years, but without the “transitional year” afforded to companies to comply with gender diversity requirements. ISS indicated that it plans to flag companies that lack racial and/or ethnic diversity on their boards in 2021 research reports and, by 2022, will begin recommending adverse or withhold votes for chairs of nominating committees and, on a case-by-case basis, directors of companies that continue to lack such diversity. (Note that California companies are now subject to gender and racial board diversity requirements, as discussed in detail here.)
In the rationale section, ISS cites SEC developments, California legislation and publications by BlackRock, State Street and various coalitions. We have begun to see diversity issues reflected in recent shareholder litigation as well, with approximately a dozen derivative lawsuits alleging that directors breached their fiduciary duties by failing to promote racial diversity in the boardroom. Critical momentum for racial and ethnic diversity policies occurred prior to the updated ISS proxy voting guidelines, which is a departure from a time when ISS was a key driver in the market for governance changes.
Climate Change
Institutional investors also appear to be influencing ISS’ position on social and environmental issues generally. Despite the outgoing administration’s resistance to acknowledging climate change, major institutional investors, like BlackRock, have been clear that companies must start giving weight to environmental realities. In Larry Fink’s 2020 letter to CEOs [2], he emphasized that “climate risk is investment risk” and called on companies to provide transparent disclosure regarding sustainability, in line with the Sustainability Accounting Standards Board’s metrics. ISS echoed Mr. Fink’s point by explicitly listing “demonstrably poor risk oversight of environmental and social issues, including climate change” as an example of failure of risk oversight, the presence of such which may result in a vote against or withhold from individual directors, committee members and the whole board.
All of this underscores that there is no one place companies can turn to for a definitive answer on how to address E&S issues. Complying with ISS policies is one part of what will have an influence on shareholder support during proxy voting, but not the complete picture as many other stakeholders will have their own views. In addition, these trends move quickly, and other constituents are in a position to change their voting policies, views, engagements and public records on topics on a faster timeline than ISS’ yearly review. Trends over the coming years will require companies to be increasingly nimble, and to consider a wide range of stakeholder views in determining what their stakeholders will find important.
ISS Weighs In On Forums For Shareholder Litigation
In 2018, the U.S. Supreme Court held that claims brought under Section 11 of the Securities Act of 1933 (the “Securities Act”) could be brought in state or federal courts.[3] Companies usually prefer these lawsuits to proceed in federal court, where it is easier to consolidate duplicative litigation and there are more robust procedural rules. In response to the Supreme Court’s decision, some companies have included federal forum provisions in their bylaws or charters. These clauses require shareholders to file lawsuits with claims brought under the Securities Act in federal courts.
The validity of federal forum provisions was the subject of litigation in Delaware, and, earlier this year, the Delaware Supreme Court held that the provisions were facially valid. The validity of these provisions “as applied” is currently being litigated in several forums across the country (with two decisions in favor of the provisions thus far, the first of which is discussed in detail here).
One might have expected ISS to oppose the adoption of federal forum provisions as restricting shareholder plaintiffs’ choice of forum. However, ISS recommends that shareholders generally vote in favor of provisions that make “the district courts of the United States” the exclusive forum for securities litigation. Adopting such provisions benefits shareholders by reducing the financial burden on companies, which otherwise bear the high costs of duplicative securities litigation in multiple forums.
In addition, ISS revised its recommendation for exclusive forums for corporate law disputes (such as derivative litigation). ISS previously recommended that shareholders vote on such forum provisions on a case-by-case basis. It now recommends that shareholders of Delaware-incorporated companies generally vote in favor of amendments to charters or bylaws that make Delaware state courts the exclusive forum for corporate law litigation. Such provisions provide companies with assurance that intricate issues of Delaware corporate law will be decided by the experienced judges of Delaware’s Court of Chancery.
Note that although ISS has recommended that shareholders vote in favor of these forum provisions, it has also recommended that they be put to a shareholder vote rather than adopted by boards without shareholder approval. In fact, ISS recommends that shareholders vote against any directors who amend bylaw or charter provisions without putting the matter to a shareholder vote.
[1] https://www.issgovernance.com/file/policy/latest/updates/Americas-Policy-Updates.pdf
[2] https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter
