ISS has opened the comment period on potential changes to its voting policies for 2020. In the U.S., ISS is seeking comment on proposed changes related to sunset provisions for multi-class stock structures, share buybacks and shareholder proposals on independent board chairs. Responses are due by October 18 at 5 p.m., E.T.
Multi-class structures. In the updates, ISS has decided that the topic of dual- or multi-class structures now merits its own policy provision, separate from other issues related to governance structure that ISS views as problematic. Under the proposed new policy, for newly public companies, ISS would generally vote against or withhold from the entire board (except new nominees, who would be considered on a case-by-case basis) if, before or as part of the IPO, the company implemented a multi-class capital structure with unequal voting rights—unless the the structure is subject to a reasonable, time-based sunset provision. By definition, however, any sunset longer than seven years would not be considered “reasonable.” Beyond that limitation, in assessing “reasonableness,” ISS would look at company lifespan, post-IPO ownership structure and rationale for the sunset. ISS would continue voting against incumbent directors for as long as the problematic practice continued.
Although the change proposed here is not dramatic, it does formalize guidance about the type of time-based sunset provision that would be acceptable to ISS. Why the change? ISS seems to be alarmed at the growth in the number of newly public companies with multi-class capital structures; in 2018, according to ISS, 14% of newly public companies had multi-class structures and, over the past four years, at least 10% employed these structures. Overall, ISS said, approximately seven percent of Russell 3000 companies currently have these capital structures. What’s more, the vast majority of these companies do not have any time-based sunset provisions. ISS contends that, while investor sentiment varies, some studies have shown that the benefit attributable to multi-class structures dissipates over time and thus justifies the call for time-based sunsets. ISS reports that 55% of investor respondents to its 2019 Global Policy Survey agreed that a maximum seven-year sunset was appropriate.
But remember that ISS also frowns on other types of shareholder protection measures that some may view as more moderate in impact than multi-class structures. Accordingly, even if a company adopts a sunset provision on its multi-class structure, ISS may still recommend against its directors (case by case) if the company retains vestiges of its other IPO protection measures, such as a classified board or supermajority vote requirements to amend the governing documents. “As such,” ISS acknowledges, “the proposed change is not expected to significantly lower the overall rate of adverse recommendations.”
Other types of problematic governance structures that are considered materially adverse to shareholder rights would, under the update, be addressed in a policy separate from the policy applicable to multi-class structures. Consistent with current ISS policy, ISS will generally recommend votes against or withhold from directors individually, committee members or the entire board (except new nominees, who would be considered on a case-by-case basis) if, before or as part of the IPO, a bylaw or charter provision is adopted that ISS identifies as problematic: specifically, classified boards and supermajority vote requirements to amend governing documents, as well as any other provision that ISS views as “egregious.” Here, a reasonable sunset provision would be considered in mitigation. As with the current policy, ISS will recommend votes for director on a case-by-case basis in subsequent years so long as the offending provision remains in place.
Shareholder proposals for independent board chair. Shareholder proposals for independent board chairs are among the most common type of shareholder proposal. For the most part, ISS views the proposed update as a codification of the existing ISS policy. The proposal identifies the factors that would make it more likely that ISS would recommend a vote in favor of the shareholder proposal:
- “A weak or poorly defined lead independent director role that fails to serve as an appropriate counterbalance to a combined CEO/chair role;
- The presence of an executive or non-independent chair in addition to the CEO, a recent recombination of the role of CEO and chair, and/or departure from a structure with an independent chair;
- Evidence that the board has failed to oversee and address material risks facing the company;
- A material governance failure, particularly if the board has failed to adequately respond to shareholder concerns or if the board has materially diminished shareholder rights; or
- Evidence that the board has failed to intervene when management’s interests are contrary to shareholders’ interests.”
ISS indicates that the discussion in the current policy of “how ISS will analyze the scope and rationale of the proposal, the company’s current board leadership structure, the company’s governance structure and practices, company performance, and the overriding factors will be updated and subsequently relocated to ISS’ Policy FAQ document.” ISS asks respondents if there are other factors that should be considered.
Share buyback proposals. Most U.S. companies conduct open-market share buybacks without shareholder votes; however, there are exceptions where a vote is required, such as for financial institutions or some U.S.-listed cross-market companies. The revised policy generally “codifies” the current ISS approach to buybacks. Shareholders tend to favor most buybacks, and ISS generally recommends votes to approve buyback authorizations. However, there are some potential hazards associated with buybacks identified in the revised policy that have led to the “rare” ISS recommendation against these proposals. To that end, the revised policy is designed to “provide safeguards against (1) the use of targeted share buybacks as greenmail or to reward company insiders by purchasing their shares at a price higher than they could receive in an open market sale, (2) the use of buybacks to boost EPS or other compensation metrics to increase payouts to executives or other insiders, and 3) repurchases that threaten a company’s long-term viability (or a bank’s capitalization level). In the absence of these abusive practices, support will generally be warranted for a grant of authority to the board to engage in a buyback.” ISS also leaves some leeway for consideration of “[o]ther company-specific factors as warranted.” The revised policy also provides that ISS would recommend votes on a case-by-case basis with regard to “proposals to repurchase shares directly from specified shareholders, balancing the stated rationale against the possibility for the repurchase authority to be misused, such as to repurchase shares from insiders at a premium to market price.” ISS asks respondents specifically whether, for U.S. companies, there may be other factors to consider, such as the potential magnitude of the buyback.