ISS and Glass Lewis have released updates to their proxy voting policies for the 2016 proxy season. [1] ISS has also modified its QuickScore 3.0 Technical Document and Equity Plan Scorecard. [2] In this post we provide guidance for U.S. public companies on addressing these developments.

Highlights of the ISS and Glass Lewis Updates

• Overboarding. Citing an “explosion” in the time commitment needed for board service, both ISS and Glass Lewis have lowered from 6 to 5 the maximum number of directorships a director (other than the CEO) may have before being considered “overboarded.” For the CEO, ISS has kept the ceiling at 3 (counting subsidiary boards separately); Glass Lewis has lowered it to 2. In 2016, overboarding will result in cautionary language in the proxy voting report; in 2017, a negative recommendation. However, in the case of overboarded CEOs, ISS will recommend against the CEO only for election to outside boards.
• Proxy Access. Neither ISS nor Glass Lewis has provided any new insight on how they will evaluate shareholder proposals on proxy access, or which proxy access bylaw provisions will be considered so restrictive as to call into question a board’s responsiveness to a majority-supported shareholder proposal. ISS promised more information in FAQs to be released in mid-December. ISS did provide a framework, similar to that used to evaluate candidates in a contested election, to evaluate candidates nominated by proxy access. ISS also added proxy access as a “zero weight” factor for QuickScore 3.0 (likely presaging a weighting next year).
• Unilateral Board Actions. Directors of IPO companies are for the first time expressly susceptible to negative recommendations if, prior to or in connection with the IPO, the company’s board adopted charter or bylaw amendments that ISS believes materially diminish shareholder rights. In addition, amendments by post-IPO companies to (1) classify the board, (2) establish supermajority vote requirements or (3) eliminate shareholders’ ability to amend bylaws will result in a negative recommendation against directors until such time as the rights are restored or the unilateral action is ratified by a shareholder vote.
• Insufficient Compensation Disclosure by Externally-Managed Issuers (EMIs). ISS will now generally recommend against say-on-pay where insufficient compensation disclosure (e.g., disclosure of only the aggregate management fee) precludes a reasonable assessment of pay programs and practices applicable to the EMI’s named executive officers. Many REITs are EMIs.
• Shareholder Proposals Seeking Environmental and Social Disclosure. ISS has clarified and somewhat broadened the criteria it will consider in evaluating shareholder proposals seeking company reports on (1) animal welfare, (2) pharmaceutical pricing and related matters and (3) climate change/greenhouse gas emissions. In the case of animal welfare, the criteria will now include practices in the supply chain.
• Conflicting Management and Shareholder Proposals. Glass Lewis now specifies the factors it will consider in assessing conflicting shareholder and management proposals. This is of increasing importance in light of the SEC’s recent indication that it will strictly construe whether a shareholder proposal is truly “conflicting” and therefore qualifies for exclusion under Rule 14a-8(i)(9).
•  Performance Failures Associated with Board Composition or Environmental or Social Risk Oversight. Glass Lewis “may consider” recommending against the nominating committee chair where it believes a board’s failure to ensure that it has directors with relevant experience, either through periodic director assessment or board refreshment, has contributed to the company’s “poor performance.” (Glass Lewis did not indicate how it will establish that board composition has contributed to “poor performance” or how it will define such performance.) Glass Lewis also has indicated that, where the board or management has failed to sufficiently identify and manage a material environmental or social risk that either did—or could—negatively impact shareholder value, it will recommend against directors responsible for risk oversight.
• Exclusive Forum Bylaws for IPO Companies. For newly public companies, Glass Lewis will no longer automatically recommend against the nominating committee chair due to the presence of an exclusive forum bylaw at the time of the IPO. Instead, Glass Lewis will consider such provision in the context of a company’s overall shareholder rights profile.

Overview of ISS Policy Changes

For the most part, the following ISS policies will become effective for meetings on or after February 1, 2016.

1. Director “Overboarding” Policy Amendments

ISS and Glass Lewis Policies—REVISED

Both ISS and Glass Lewis lowered the maximum number of directorships a director nominee other than the company’s sitting CEO may have before being considered “overboarded.” Departing from its policy draft, ISS did not lower its ceiling for CEOs, while Glass Lewis did so for CEOs and other executive officers. ISS and Glass Lewis both provide a one-year transition period: for the 2016 proxy season, they will only include cautionary language about the overboarded director in the proxy voting recommendation report. Not until meetings commencing in 2017 (February 2017 for ISS) will overboarding under the new limits result in a negative recommendation.

Under ISS’ guidelines, all subsidiary boards on which a CEO sits will be counted as separate boards. ISS will not recommend a withhold vote from the CEO of a parent company board or any of the controlled (>50% ownership) subsidiaries of that parent, but may do so at subsidiaries that are less than 50% controlled and boards outside the parent/subsidiary relationship. However, in the case of overboarded CEOs, ISS will recommend against the CEO only for election to outside boards.

The ISS and Glass Lewis changes are reflected in the following table:

What To Do Now?

• Evaluate whether your company’s directors, including the company’s CEO or other executive officers, could be at risk of receiving a public caution from ISS or Glass Lewis and, subsequently, a negative recommendation under the revised overboarding policies.

• Ensure that directors and executive officers update their annual questionnaires to provide current biographies, including all other boards on which they serve (both public and private). Companies should have a policy requiring prompt notice of changes in employment or directorships and directors and executive officers should be periodically refreshed about this policy. Directors and executive officers should be particularly mindful about potential overboarding that may arise from board service on private companies that anticipate an IPO.

2. Candidates Nominated by Proxy Access—NEW

ISS has added an analytical framework for evaluating candidates nominated by proxy access. ISS will make voting recommendations on a case-by-case basis, considering the same factors currently used to evaluate nominees in a proxy contest, [3] “or additional factors which may be relevant.” ISS did not provide specific guidance on “additional relevant factors” other than to state they may be specific to the company, to the nominee(s), and/or to the nature of the election (such as whether or not there are more candidates than board seats).

What To Do Now?

• It remains to be seen how proxy access will be used by shareholders of those companies that adopt it in time for the 2016 proxy season and, if used, how proxy access candidates will be evaluated by ISS.
• Companies should stay informed on proxy access issues and developments. We provide a strategic roadmap for decision-making about proxy access in our Alert available here.

3. Unilateral Board Actions—REVISED

Last year, ISS adopted a new stand-alone policy under which it will generally issue a negative recommendation against director nominees (except new nominees, whom it considers case-by-case), if the board amends the company’s bylaws or charter without shareholder approval or ratification in a manner that ISS believes materially diminishes shareholders’ rights or could adversely impact shareholders. The policy listed factors that ISS considered when formulating its recommendation, but did not specify for how many years it would issue negative recommendations or what types of amendments it would view as materially diminishing shareholder rights. Moreover, the policy did not make a distinction between newly public companies and those that have been public for some period of time. For a summary of the 2015 voting policy updates, see our Alert available here.

ISS amended its policy to explicitly state that, beginning for the 2016 proxy season, charter and bylaw amendments made by post-IPO companies to (1) classify the board, (2) establish supermajority vote requirements or (3) eliminate shareholders’ ability to amend bylaws will result in a negative recommendation for director nominees until such time as the shareholders’ rights are restored or the unilateral action is ratified by a shareholder vote.

In addition, for the 2016 proxy season, ISS has established separate methodologies to evaluate bylaw or charter provisions adopted prior to or in connection with a company’s IPO and unilateral board amendments made to the bylaws or charter following an IPO.

What To Do Now?

• Companies, including those preparing for an IPO, that are considering whether to amend their charter or bylaws in a manner that could be viewed by ISS to adversely impact shareholders should carefully consider the impact of such amendments on director elections but should continue to make decisions in the best interest of the company, especially during the IPO transition period.

• Companies that recently became public or are preparing for an IPO should note what may be a suggestion from ISS that disclosure of a public commitment to put any adverse shareholder provisions to a shareholder vote within three years of the IPO date may result in a period of “grace” during the company’s formative years in the public domain.

4. Insufficient Compensation Disclosure at Externally-Managed Issuers—Now a “Problematic Pay Practice”—NEW

ISS has adopted a new voting policy under which it will generally recommend against say-on-pay when the EMI fails to provide sufficient compensation disclosure to allow investors to make a reasonable assessment of pay programs and practices for the EMI’s named executive officers.

ISS expressed concern over the lack of transparency in the compensation disclosure made by EMIs, as well as potential conflicts of interest underpinning such compensation arrangements. EMIs pay fees to an external management firm in exchange for management services and, in most cases, executives of the EMIs are compensated by the external manager. Disclosure is often limited to the aggregate management fees paid by the EMI to the manager. In ISS’ view, EMIs typically do not disclose the compensation arrangements and payments made to the

EMI executives by the external manager in sufficient detail to enable shareholders to make an informed pay-for- performance evaluation. ISS further notes that a small number of EMIs disclose detailed compensation information, which ISS uses to support its conclusion that such information can be made available within the constraints of company agreements with external managers.

What To Do Now?

• The compensation committee of an EMI should review prior proxy statement disclosure on compensation of its NEOs by the external manager and consider whether expansion is warranted this year in light of ISS’ new policy.

5. Voting Recommendations on Certain Shareholder Proposals Equity Holding Periods for Executives—REVISED

ISS has streamlined its policy with respect to shareholder proposals asking companies to adopt policies requiring executive officers to retain all or a significant portion of net shares acquired through compensation plans. These proposals typically include retention periods of up to two years after termination of employment or during a lock-up period after vesting.

The revisions broaden ISS’ policy to encompass equity retention proposals more generally, eliminating the need for a separate policy tied to a specific retention ratio (e.g., 75% of net shares). The revised policy clarifies that the suggested retention ratio and the required duration remain two factors that ISS will strongly consider. In addition, the revised policy applies to executive officers, rather than the previously bifurcated policy for named executive officers and senior executive officers.

Under the revised policy, ISS will recommend case-by-case on shareholder proposals seeking the adoption of share retention policies for executive officers, taking into account:

• The percentage/ratio of net shares required to be retained
• Time period required to retain the shares
• Whether the company has equity retention, holding periods, or stock ownership requirements and the robustness of such requirements
• Compensation policies aimed a mitigating executive risk taking
• Executives’ actual stock ownership and the degree it meets or exceeds the thresholds in the proposal
• Problematic pay practices, current and past, which may demonstrate a short-term versus long-term focus.

6. Proposals on Environmental and Social Issue Disclosure—REVISED

• Animal Welfare. ISS revised its voting policy recommendation relating to proposals seeking a report on a company’s animal welfare policy to also cover reports on animal welfare-related risks (not just animal welfare standards). Under the revised policy, ISS will generally vote “for” proposals seeking such reports unless: (1) the company has already published a set of animal welfare standards and monitors compliance; (2) the company’s standards are comparable to industry peers; and (3) there are no recent, significant fines, litigation, or controversies related to the company’s and/or its suppliers’ treatment of animals. The revised policy added animal treatment “controversies” and “suppliers’ treatment” of animals to the list of evaluated criteria.

• Pharmaceutical Pricing, Access to Medicines, and Prescription Drug Reimportation. Generally ISS will recommend case-by-case on shareholder proposals requesting that a company report on its product pricing or access to medicine policies after considering certain factors. ISS added to its list of criteria: (1) recent significant controversies, litigation, or fines at the company and (2) the potential for “regulatory” risk exposure.

• Climate Change / Greenhouse Gas (GHG) Emissions: ISS will generally support shareholder proposals asking that a company disclose information on risks related to climate change on its operations and investments. ISS has clarified the types of climate change risks for which it will support disclosure to include financial, physical, and regulatory risks.

What To Do Now?

• Companies receiving shareholder proposals on these matters should consult ISS’ new policy. This policy reflects the growing interest of investors and other stakeholders in corporate social responsibility matters and a trend toward voluntary disclosure by larger U.S. public companies.

Overview of Glass Lewis Policy Changes

1. Conflicting Management and Shareholder Proposals—NEW

Against the backdrop of dueling shareholder and management proposals on proxy access during the 2015 proxy season, and recent guidance in SEC Staff Legal Bulletin No. 14H indicating that the SEC will strictly construe whether a shareholder proposal truly conflicts with a management proposal and therefore qualifies for exclusion, [6] Glass Lewis has clarified how it will evaluate conflicting proposals during the 2016 proxy season. Glass Lewis will consider the following factors when reviewing conflicting management and shareholder proposals:

• Nature of the underlying issue

• Benefit to shareholders by implementing the proposal

• Materiality of the differences between the terms of the shareholder and management proposal

• Appropriateness of the provisions considering the company’s shareholder base, corporate structure, and other relevant circumstances

• The company’s overall governance profile, specifically including its responsiveness to shareholders evidenced by the company’s response to previous shareholder proposals and its adoption of progressive shareholder rights provisions.

What To Do Now?

• Companies that anticipate having management and shareholder proposals on the same topic in their proxy statement should review the factors that Glass Lewis has enumerated, as well as the new SEC guidance. We provide a summary of the SEC’s recent guidance in our Alert available here.

2. Nominating Committee Performance: Failures Associated with Board Composition—REVISED

Glass Lewis may now recommend against the nominating and governance committee chair “where the board’s failure to ensure the board has directors with relevant experience, either through periodic director assessment or board refreshment, has contributed to a company’s poor performance.” The revised policy does not indicate how Glass Lewis determines when a director’s experience contributed to poor company performance, nor does it define “poor performance.” However, in another Glass Lewis voting guideline relating to company performance, Glass Lewis indicates that poor performance is “[in] the last three years . . . performance [that] has been in the bottom quartile of the [company’s] sector.”

What To Do Now?

• Ensure company disclosure contains thorough descriptions of the specific experience, qualifications, attributes or skills that led to the conclusion that each director should be nominated in light of the company’s business and structure as required by Item 401(e) of Regulation S-K.

• Ensure that the company is conducting regular and robust board evaluations. Note that ISS QuickScore 3.0 has been revised to consider whether the board is conducting individual director assessments.

3. Environmental and Social Risk Oversight—NEW

Beginning in the 2016 proxy season, Glass Lewis will recommend against directors responsible for risk oversight in cases where the board or management failed to sufficiently identify and manage a “material environmental or social risk” that did or could negatively impact shareholder value. Glass Lewis reasoned that the identification, mitigation and management of environmental and social risks are integral components when evaluating a company’s overall risk exposure. While the policy does not define environment or social risk, the Glass Lewis Shareholder Initiatives Guidelines indicate that examples of environmental risks include oil or gas spills, contamination, hazardous leakages, explosions, or reduced water and air quality; social risks include non-inclusive employment policies or inadequate human rights policies.

What To Do Now?

• Companies that have previously faced shareholder criticism, negative proxy advisory firm recommendations or shareholder proposals relating to environmental or social issues should consider enhancing disclosure regarding the board’s oversight process specifically in these areas.

4. Exclusive Forum Bylaws for IPO Companies—REVISED

For the 2015 proxy season, Glass Lewis amended its voting policy to automatically recommend a vote against the nominating and governance committee chair (or the entire committee) if the board adopted an exclusive forum bylaw pre-IPO. Under Glass Lewis’ relaxed policy, if a company adopts an exclusive forum bylaw provision pre-IPO, Glass Lewis will no longer automatically make such negative recommendation. Instead, Glass Lewis will weigh the presence of an exclusive forum provision in a newly-public company’s bylaws in light of other provisions that may limit shareholder rights, such as supermajority vote requirements, a classified board, or a fee-shifting bylaw.

Glass Lewis has not changed its policy to automatically recommend against the nominating and governance committee chair (or the entire committee) when a company adopts an exclusive forum provision without shareholder approval outside of the spin-off, merger or IPO context. ISS, on the other hand, does not recommend voting against directors based on the unilateral adoption of an exclusive forum bylaw provision and reviews exclusive forum bylaws on a case-by-case basis.

What To Do Now?

• Newly public companies and those preparing for an IPO should consider their shareholder rights profile in its entirety in evaluating whether to implement an exclusive forum provision.
• Remember that Glass Lewis will continue to recommend against the chair or the entire committee when a company adopts a fee-shifting bylaw pre-IPO, if such provision is not subject to a shareholder vote following the IPO.

5. Compensation Policy Updates—REVISED

Glass Lewis has updated the following disclosure and compensation policies:

• Long-Term Incentives—Glass Lewis will look to see whether a company has disclosed actual performance and vesting levels for previous grants earned during the fiscal year.

• Transitional Awards—While acknowledging that there are costs associated with transitions at the executive level, Glass Lewis believes that sign-on arrangements should be clearly disclosed and accompanied by meaningful explanation of the payments and process for determining the payment amounts, including any “make-whole” payments.

• Equity Compensation Plans—Glass Lewis analyzes equity-based compensation plans based on quantitative and qualitative factors. The revised policy clarifies that additional qualitative factors include the choice of, use of, and difficulty in meeting award metrics and targets (if any). Other factors, such as the company’s size and operating environment, may be relevant in assessing the concerns or benefits of certain changes to equity compensation plans. Glass Lewis may also consider a company’s overall executive compensation practices when evaluating certain equity compensation plans.

What To Do Now?

• In preparing their CD&As, companies should take into account Glass Lewis’ updated expectations about disclosure of long-term incentives, transitional awards and equity compensation plans, as applicable.

QuickScore 3.0 Updates

ISS has revised its QuickScore 3.0 Technical Document. A copy of the revised QuickScore 3.0 technical document is available for download at http://www.issgovernance.com/governance-solutions/investment-tools-data/quickscore/.

ISS has added one new “zero weight” factor regarding proxy access and modified existing factors applicable to U.S. public companies. New company QuickScores will be published will begin to appear in ISS research reports on November 23, 2015.

1. New Zero-Weight Factor—Proxy Access (Q346)

• QuickScore will now track whether companies provide proxy access and, if so, the following specifics: (1) the ownership threshold and holding period required to exercise the proxy access right, (2) the number of shareholders permitted to aggregate their holdings, and (3) the number or percentage of board seats available for proxy access nominees. For 2016, this will be a zero-weight factor, meaning the factor will be noted on the QuickScore report but will not impact the numerical QuickScore. We expect this to be weighted in 2017.

2. Modified Factors and Other Changes

ISS has modified certain factors applicable to U.S. public companies:

• Policy requiring annual performance evaluation of the board (Q41)—ISS QuickScore considers whether the company has disclosed a policy requiring an annual performance evaluation of the boa ISS has clarified that, for U.S. companies, a “robust” policy exists when the company discloses an annual board performance evaluation policy that includes (1) individual director assessments and (2) an external evaluation performed at least every three years. This revised interpretation is likely to affect a company’s QuickScore given that many companies conduct evaluations at the board and committee level rather than at the individual director level, and typically through a company-managed process.
• Proportion of non-executive directors on the board with a lengthy tenure (Q13)—ISS clarified that a “small number” of long-tenured directors (i.e., those on the board longer than 9 years) does not negatively impact the company’s QuickScore governance rating. QuickScore does not quantify the term “small number.” To date, we have generally found that companies receive a QuickScore “red flag” when long-tenured directors represent more than one-third of the board.
• Board and committee meeting attendance (Q45)—ISS clarified that for U.S. companies, this question applies to all board and committee meetings “as set forth under SEC disclosure requirements,” indicating the ISS attendance policy applies to all committees of the board, and not exclusively the audit, compensation, and nominating/governance committees. [7]
• Majority voting policy (Q52)—ISS clarified that a director resignation policy (typically found in the company’s corporate governance guidelines) is not considered to be the same as a “majority voting standard” located in the company’s certificate of incorporation or bylaws.
• Adverse auditor opinions (Q2)—QuickScore has added an “emphasis of matter” disclosure in the audit report to its evaluation of whether a company received an adverse opinion from its audit It is not clear if an “emphasis of matter” disclosure will result in a QuickScore “red flag.”
• Enforcement action against a director or officer of the company in the past two years (Q200)—ISS clarified that any penalty against a director or officer is considered to be “material” when it considers whether an officer or director was subject to an enforcement action by a regulator within the past two years, and if the investigation was resolved with a material penalty.
• Regulatory investigations (Q201)—QuickScore evaluates whether the company, directors, or officers are under a regulatory investigation, which is categorized either as “routine” or “non-routine.” ISS has clarified that FCPA- related investigations and Wells Notices are generally considered to be non-routine investigations, unless the company states the outcome is not expected to have a material adverse effect on the company. Accounting investigations are considered “routine,” unless tied to a restatement.

What To Do Now?

• Once issued, review your QuickScore and continue provide feedback via the ISS data verification website. Feedback should reference public filings, where appropriate. It is important to provide feedback as soon as possible because data verification is not available during the period between the filing of a company’s proxy statement and the publication of ISS’ proxy analysis for the company’s annual meeting. Information about verifying data, how to obtain log-in information and a link to the data verification website is available at http://www.isscorporatesolutions.com/quickscore-dataverification.
• Where appropriate, enhance discussion in the company’s upcoming proxy statement relating to elements of QuickScore that have been newly modified as summarized above.
• Remember that companies that have adopted many of the best practices advocated by ISS may nevertheless find themselves with QuickScores that are in the middle of the pack or below average, as each QuickScore will reflect a company’s relative rank. Directors and management should continue to make governance decisions in the best interests of the company, depending on the company’s particular circumstances, rather than be driven by a desire to increase QuickScores in line with rigid one-size-fits-all prescriptions.

Equity Plan Scorecard Updates

For the 2015 proxy season, ISS adopted a new Equity Plan Scorecard (EPSC) for evaluating equity compensation plans by considering a range of positive and negative factors, rather than a series of “pass” or “fail” tests. Positive and negative factors can counterbalance each other. The Scorecard factors fall under three enumerated “pillars” weighted by reference to company size and status. For S&P 500 and Russell 3000 companies these pillars and weighting are as follows: Plan Cost—45%, Plan Features—20% and Grant Practices—35%. Additional information about the EPSC is provided in our Alert available here. Generally, the EPSC policy has not changed for S&P 500 and Russell 3000 companies.

ISS has amended the EPSC FAQs for company meetings beginning on or after February 1, 2016, available here, as follows:

• ISS has created a new “Special Cases—Russell 3000 / S&P 500.” This includes companies that have recently become public or emerged from bankruptcy. Maximum pillar scores for this new category are as follows: Plan Cost—50%; Plan Features—35%, and Grant Practices—35%. For these companies, the Grant Practices pillar will not include burn rate and duration.
• For all companies, the Plan Features factor called “Automatic Single-Trigger Vesting” is renamed to “CIC Vesting,” with the following scoring levels:
  • Full points if plan provides (1) for time-based awards: no acceleration or accelerated vesting only if awards are not assumed/converted and (2) for performance-based awards: forfeited, terminated, paid pro-rata and/or based on actual performance.
  • No points if plan provides for automatic acceleration of time-based equity or above-target vesting of performance awards.
  • Half points if plan provides for any other vesting terms related to a CIC.
• For the “Post-Vesting/Exercise Holding Period” Plan Features, the period required for full points has been revised to 36 months (up from 12 months) or until employment terminati Half points will accrue for a 12 month holding period.
• The maximum of 100 total points and the threshold of 53 points for a favorable recommendation remain unchanged.

What To Do Now?

• Companies planning to include an equity compensation plan on the ballot for the next annual meeting should register to gain access to the ISS Equity Plan Data Verification Portal and review the data points about the company that ISS will consider as part of its scorecard.