‘Tis the Season for Proxy Voting Guidelines

It’s that time of the year again. No, not the post-holiday anxiety that comes with  keeping your New Year’s resolutions … the 2016 proxy season voting updates from proxy advisories like Institutional Shareholder Services (ISS) and Glass Lewis.

The US guidelines will go into effect on Feb. 1, 2016, and not much is new. The two biggies include updates to unilateral bylaw/charter amendments and “over-boarding” – the latter of which both ISS and Glass Lewis amended for the 2016 season.

Bylaws Now Scrutinized Pre-IPO

The current recommendation by ISS is to generally vote against directors who amend corporate bylaws “without shareholder approval in a manner that materially diminishes shareholders' rights or that could adversely impact shareholders.”

We saw in 2015 that this included bylaws like fee-shifting (aka “loser pays”).

This year, updates to the ISS voting guidelines include looking at the bylaws adopted pre-IPO. Key changes include:

Separate the methodology for evaluating adoptions of bylaw or charter provisions made prior to or in connection with a company's initial public offering from the methodology for evaluating unilateral board amendments to the bylaws or charter made following completion of a company's initial public offering, and

Explicitly state that ISS will consider both such actions in determining vote recommendations for director nominees until such time as the actions are reversed or submitted to a binding vote of public shareholders.

In other words, public company board members (or at least governance committee chairs) could get a “no” vote from the ISS at their first annual meeting as a public company post-IPO, based on pre-IPO decisions.

The fact of the matter is that most IPO companies – certainly most IPO companies out of Silicon Valley – routinely put in place provisions that are designed to allow the company to operate without the worry of being taken over by shareholder activists or otherwise, at least for the first few post-IPO years.

These mechanisms allow the newly public company to focus on running the business without the distraction of activist shareholders who may be motivated to prematurely push a company away from its stated strategy or engage in frivolous litigation as much as possible (for example, choice of forum provisions).

ISS sees it differently. As it writes in the 2016 guidelines that “while some pre-IPO boards argue that these governance structures will benefit investors over the long run, few of them provide opportunities for post-IPO shareholders to ratify these provisions.”

ISS then cited data which showed 69 percent of 400 “emerging growth” companies that completed an IPO between January 2013 and December 2014 “went public with classified boards and nearly three-quarters had supermajority vote requirements in place.”

It’s worth noting that most pre-IPO companies obtain an affirmative vote in favor of these types of provisions from the owners of the private company before putting them in place.

It’s also worth noting that public company shareholders purchase shares of the IPO with the full knowledge (as disclosed in the IPO prospectus) that they’re buying shares of a company that has implemented provisions like choice of forum or a classified board.

Is the ISS Overreaching Here?

Certainly the argument that ISS has to aggressively protect public company shareholders from misbehaving directors who unilaterally strip away rights from their shareholders does not seem to apply in the context of an IPO company where new investors knowingly come to the risk.

Glass Lewis’ latest update makes it clear that they will recommend a “no” vote for directors who adopt poison pills or classified boards before their company’s IPO.

However, if these items have a sunset provision of three years or less, Glass Lewis will refrain from recommending a “no” vote. Its reasoning is that these pre-IPO measures overly insulate management and the board to the detriment of future shareholders.

The fact that these future shareholders could refrain from buying the stock is not compelling for Glass Lewis. This is in part because some of its institutional clients are required to purchase stock on an index basis, and thus cannot express their disagreement with these mechanisms by selling their shares. The same is true for ISS.

Going Overboard

“Over-boarding” is a reference to a director sitting on too many boards to be able to give each board a sufficient amount of attention. For 2016, both ISS and Glass Lewis have lowered what they view as the acceptable number of board seats any one director should take.

In addition, in 2016, both ISS and Glass Lewis will consider whether the director in question is the sitting CEO of a public company.

Citing recent data from a survey by the National Association of Corporate Directors’, ISS writes that “directors of public companies now spend an average of 242 hours a year (or more than 30 eight-hour work days annually) on board service.”

ISS also cites that academic research shows negative association between being busy and performance.

Key changes with regards to over-boarding from ISS include:

In 2016, ISS will note in its analysis if a director is serving on more than five (5) public company boards.

Starting in February of 2017, ISS will recommend against directors who sit on more than five (5) public company boards.

The new recommendation is a “no” vote for individual directors who:

Sit on more than six public company boards; for meetings on or after Feb. 1, 2017, sit on more than five public company boards; or

Are CEOs of public companies who sit on the boards of more than two public companies besides their own - withhold only at their outside boards.

Glass Lewis announced that it will modify its threshold from more than six directorships to five in 2017, and in 2016, it will review the commitments of directors who sit on more than six boards. And for CEOs, Glass Lewis lowered it to two.

Grade A Experience, Grade A Director?

Also of note is Glass Lewis’ recommendation to vote against the chair of the nominating and governance committee if a company’s poor performance can be attributed in part to having unqualified board members.

The Glass Lewis stance is that shareholders should vote against “directors who have served on boards or as executives of companies with records of poor performance, inadequate risk oversight, excessive compensation, audit or accounting-related issues, and/or other indicators of mismanagement or actions against the interests of shareholders.”

It’s not clear how Glass Lewis will make their assessments. They have mentioned that they will consider board evaluation as well as board refreshment.

Glass Lewis has also specifically stated that “we examine the backgrounds of those who serve on key board committees to ensure they have the required skills and diverse backgrounds to make informed judgments about the subject matter for which the committee is responsible.”

This seems reasonable, and it’s perhaps also important to remember that credentialing is often not the entire story.

The poster child for this point is, of course, the Enron board – the one that was in place as Enron collapsed in 2001. On paper, it had stellar credentials. The Enron board had long been considered one of the best boards on the planet.

Unfortunately credentials turned out not to be a very good proxy for the quality of that board’s engagement with the business.

The 2016 proxy season will be in full swing very soon. It will no doubt be another interesting year for directors, proxy solicitation services and the shareholders they both are supposed to serve.

The views expressed in this blog are solely those of the author. This blog should not be taken as insurance or legal advice for your particular situation. Questions? Comments? Concerns? Email: phuskins@woodruffsawyer.com.