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E-MailCydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum.
This week, ISS issued its benchmark policy updates for 2022. The policy changes will apply to shareholder meetings held on or after February 1, 2022. The key changes for U.S. companies relate to say-on-climate proposals, board diversity, board accountability for climate disclosure by high GHG emitters, board accountability for unequal voting rights and shareholder proposals for racial equity audits, as well as the decidedly less buzzy topics of capital stock authorizations and burn rate methodology in compensation plans.
Say on climate. The policy updates distinguish between management proposals and proposals submitted by shareholders. In both cases, proposals will be evaluated on a case-by-case basis, but the factors taken into account will differ.
ISS indicates that its policy for management proposals represents a codification of the framework it developed last year, adjusted for relevant feedback. For management proposals that request shareholders to approve the company’s climate transition action plan (or variations of same), ISS will take into account a long list of factors, including the completeness and rigor of the plan, the extent to which the company’s climate-related disclosures align with the TCFD recommendations and other market standards; disclosure of the company’s scope 1, 2 and 3 GHG emissions; the completeness and rigor of the company’s short-, medium- and long-term targets for reducing GHG emissions in line with the Paris Agreement; whether the company has sought and received third-party approval that its targets are science-based; whether the company has committed to be “net zero” for Scopes 1, 2, and 3 emissions by 2050; whether the company discloses a commitment to report on the implementation of its plan in subsequent years; whether the company’s climate data has received third-party assurance; disclosure regarding how the company’s lobbying activities and its capital expenditures align with company strategy; any specific industry decarbonization challenges; and how the company’s commitment, disclosure and performance compare to its industry peers. And that list isn’t even exhaustive.
Shareholder say-on-climate proposals generally include requests for the company “to disclose a report providing its GHG emissions levels and reduction targets and/or its upcoming/approved climate transition action plan and provide shareholders the opportunity to regularly express approval or disapproval of its GHG emissions reduction plan.” In evaluating those proposals, ISS will take into account information such as the completeness and rigor of the company’s climate-related disclosure; the company’s actual GHG emissions performance; whether the company has been the subject of “recent, significant violations, fines, litigation, or controversy related to its GHG emissions”; and whether the proposal is “unduly burdensome” or “overly prescriptive.”
SideBar
“Say on climate” is a new proposal that, just like “say on pay,” asks companies to hold annual advisory votes on their climate policies and strategies. According to the 2021 proxy season review from Alliance Advisors, say on climate was one of the new entries among the shareholder proposals that received support averaging around 30%, a level that Alliance characterizes as “remarkably” good for first timers. Alliance acknowledged that these results did not come entirely out of the blue, as large asset managers such as BlackRock and Vanguard had previously signaled that they might take steps this past season to more closely align their proxy voting records with their advocacy positions. Alliance reported that a proponent of say-on-climate plans to submit the proposal to 100 companies in the S&P 500 by the end of 2022. Of the four proposals that went to a vote, three received over 30% support, and one that was framed as a binding bylaw received only 7%. Two companies that just went ahead and requested votes on say on climate received over 90% approval. Interestingly, there seem to be mixed views on these proposals. For example, Alliance points out that Glass Lewis “expressed concern that SOC votes could result in a rubber stamping of weak climate strategies.” (See this PubCo post.)
For management proposals, ISS reports that a number of commenters on the proposal advocated that ISS “benchmark the plans against alignment with a 1.5-degree or Net Zero scenarios, and/or to require that all scopes of emissions be included in any transition plan.”
For shareholder proposals, a number of commenters on the ISS proposed policy were not supportive or expressed concerns about say-on-climate votes, fearing that they “may detract from the board’s responsibilities for strategy and risk management.”
Board diversity. Currently, for a company in the Russell 3000 or S&P 1500, ISS policy is generally to vote against or withhold from the chair of the nominating committee (or other directors on a case-by-case basis) at companies where there are no women on the company’s board. ISS proposes to expand the application of that policy to companies beyond the Russell 3000 and S&P 1500, after a one-year grace period, for meetings on or after February 1, 2023. Noting the strong preference expressed by institutional investors, as well as the recent Nasdaq listing rule change on board diversity, ISS believes that this policy change “will align U.S. benchmark policy with client and market expectations on gender diversity.”
In comments on the proposal, while a small number of companies contended that director nominations should be the exclusive province of the board, ISS reports that most comments were supportive of the proposed policy changes. In response to a question from ISS, no investors said that the size of the board should be a consideration for the board gender diversity policy.
SideBar
In August, the SEC approved the Nasdaq proposal for new listing rules regarding board diversity and disclosure, as well as an accompanying proposal to provide free access to a board recruiting service. The new listing rules adopt a “comply or explain” mandate for board diversity for most listed companies and require companies listed on Nasdaq’s U.S. exchange to publicly disclose “consistent, transparent diversity statistics” regarding the composition of their boards. To refute potential criticism of the board diversity proposal as a quota in disguise, Nasdaq took great pains to frame its proposal as principally “a disclosure-based framework and not a mandate.” The Nasdaq board diversity rule sets a “recommended objective” for most Nasdaq-listed companies to have at least two diverse directors on their boards; if they do not meet that objective, they will need to explain their rationales for not doing so. The proposal also requires listed companies to provide annually, in a board diversity matrix format, statistical information regarding the company’s board of directors related to the directors’ self-identified gender, race and self-identification as LGBTQ+. (See this PubCo post.)
With regard to racial and ethnic diversity, ISS adopted a policy in 2021 that provided a one-year grace period. That period has now passed and, as a result, for 2022, for companies in the Russell 3000 or S&P 1500, ISS will issue adverse vote recommendations, generally voting “against or withhold from the chair of the nominating committee (or other directors on a case-by-case basis) where the board has no apparent ethnically or racially diverse members.” An “exception will be made if there was racial and/or ethnic diversity on the board at the preceding annual meeting and the board makes a firm commitment to appoint at least one racial and/or ethnic diverse member within a year.” ISS reported that, in comments on the proposed policy, some investors wanted to see the policy on racially diverse boards applied more broadly to other markets.
Board accountability for unequal voting rights. In 2015, ISS adopted a policy to vote against directors of newly public companies that retained certain governance provisions that ISS disapproved, including multi-class capital structures with unequal voting rights (in the absence of a reasonable sunset of no more than seven years), classified boards and companies with supermajority vote requirements to amend governing documents. In addition, the policy provides that ISS will continue to vote against or withhold from incumbent directors in subsequent years unless the company reverses or removes the structure or adds a new reasonable sunset provision. Notably, however, ISS grandfathered companies that already had these provisions.
As indicated in the results of ISS’s recent benchmark policy survey (see this PubCo post), among investors, 94% advocated that ISS revisit the grandfathering policy, and 57% of non-investors had the same view. The vast majority of both investors and non-investors ranked multi-class capital structures with unequal voting rights first on the list to be reconsidered. ISS contends that “[e]ach additional year subsequent to the initial policy implementation creates a discernable schism between recently-public companies that are impacted by the policy and long-standing grandfathered public companies that are not.”
Under its new policy changes, ISS is now removing the policy differential that arose out of that grandfathering. Companies will have a one-year grace period in 2022. Under the new policy, beginning with meetings on and after February 1, 2023, ISS will generally recommend a withhold or against vote for directors individually, committee members or the entire board (except new nominees, who would be considered on a case-by-case basis), if the company has a common stock structure with unequal voting rights, including classes of common stock that have additional votes per share, classes of shares that are not entitled to vote on all the same ballot items or nominees, or stock with time-phased voting rights. There would be some exceptions, including for newly public companies that have a sunset provision of no more than seven years from the date of going public, limited partnerships and REITs, circumstances where the unequal voting rights are considered de minimis or where the “company provides sufficient protections for minority shareholders, such as allowing minority shareholders a regular binding vote on whether the capital structure should be maintained.” ISS observes that the new policy means that “starting in 2023, ISS will likely be recommending against directors at many large or iconic U.S. companies that have unequal voting rights structures.” Other changes include identifying SPACs as “newly public.”
ISS reports that, in comments on the proposal, investors tended to favor one-share-one-vote structures and thus supported the proposal, “even though they recognized that it would often be for the purpose primarily of sending a signal to the board.” One investor also wanted to see changes in the treatment of the other “problematic provisions.” Companies “tended not to support the change, saying that directors currently serving on the board did not have the authority to change the companies’ share structures.”
SideBar
In 2018, the Council of Institutional Investors announced that it had filed petitions with the NYSE and Nasdaq requesting that each exchange amend its listing standards to address the issue of multi-class capital structures. As requested by the petition, the amendment would require that, going forward, companies seeking to list with multi-class share structures include provisions in their governing documents that would sunset the unequal voting at seven years following an IPO and return the structure to “one-share, one-vote” structures, “subject to extension by additional terms of no more than seven years each, by vote of a majority of outstanding shares of each share class, voting separately, on a one-share, one-vote basis.” CII argued that unequal voting rights impair the ability of shareholders “to hold executives and directors accountable.” But companies contended that these measures were being adopted for a valid reason: to protect the company from unwanted interventions by hedge-fund activists with short-term goals and perspectives. Accordingly, the debate centered around whether these measures were a legitimate effort to protect companies from the pressures of short-termism exerted by hedge-fund activists and others or were a mechanism that caused shareholders to cede power without providing accountability. (See this PubCo post.)
Board accountability for climate. As we all know, climate change and climate-related risk disclosure are top of mind for many investors. ISS is adopting policy changes for 2022 that focus on companies that are the highest GHG emitters, that is, those companies on the current Climate Action 100+ Focus Group list.
Under the new policy, for companies that, through their operations or value chain, are significant GHG emitters, ISS will generally recommend votes against or withhold from the incumbent chair of the responsible committee (or other directors on a case-by-case basis) “where ISS determines that the company is not taking the minimum steps needed to understand, assess, and mitigate risks related to climate change to the company and the larger economy.”
What does that mean? For 2022, these minimum steps include satisfaction of both of the following minimum criteria:
- “Detailed disclosure of climate-related risks, such as according to the framework established by the [TCFD], including:
- Board governance measures;
- Corporate strategy;
- Risk management analyses; and
- Metrics and targets.
- Appropriate GHG emissions reduction targets,” that is, for 2022, “any well-defined GHG reduction targets.”
Scope 3 targets will not be required for 2022, but “targets should cover at least a significant portion of the company’s direct emissions.” ISS makes clear that its expectations about the steps that will suffice as “minimum steps to mitigate risks related to climate change” will increase over time.
SideBar
In responses to ISS’s 2021 Climate Policy survey, the vast majority of investors “supported establishing minimum criteria for companies considered to be strongly contributing to climate change.” In the survey, respondents were asked to identify, for companies that were considered strong contributors to climate change, the types of disclosures they should provide at a minimum. Highest on the list, for both investors and non-investors, was “clear and appropriately detailed disclosure of its climate change emissions governance, strategy, risk mitigation efforts, and metrics and targets,” such as under the TCFD framework. Next, for investors, was declaring a “long-term ambition to be in line with Paris Agreement goals,” followed by demonstrating that “it is improving its disclosure and performance (even if it is not yet in line with peers or with Paris Agreement goals), reporting “to show that its corporate and trade association lobbying activities are in alignment (or are not in contradiction) with limiting global warming in line with Paris Agreement goals,” and disclosing “a strategy and capital expenditure program in line with GHG reductions targets that could reasonably be seen to be in line with limiting global warming to ‘well below 2 degrees C’ (Paris Agreement goals).” In these instances, the responses from non-investors reflected lower percentages than for investors. According to ISS, corporate responders were also “strongly supportive of disclosure and demonstrating improvement, although support drops precipitously for ambition and targets in line with Paris goals.”
What did the survey show about companies that are not considered strong contributors to climate change? Should they be held to the same minimum standards? The survey showed that one-third of investor respondents and a majority of non-profits thought they should, but most often, investors and corporate responders set their expectations lower. (See this PubCo post.)
ISS indicates that, in comments on the proposal, investors largely supported the policy and encouraged ISS to go farther, as well as to “recommend against directors at significant GHG emitters that have not declared a Net Zero ambition and that do not have well-defined short-, medium-, and long-term transition targets toward Net Zero across all scopes.” Some investors and non-profits coordinated responses, finding the policy inadequate because it did not require targets to be “aligned with a 1.5-degree scenario” or require Scope 3 targets or because the universe of companies subject to the policy was too narrow and excluded “banks and financial institutions. Other potential metrics that some commenters highlighted as important were board and director climate competence, disclosure of climate-related lobbying priorities for direct and indirect lobbying, executive remuneration, impact of transition on workers and communities, and incorporation of risks into financial accounts.” ISS advised that all “comments received will continue to be taken into consideration as [ISS continues] to develop ISS policy approaches to climate over future years.”
Company commenters were of apparently mixed views, some supportive and some opposed. Some of those opposed contended that “ISS should give CA100+ Focus Group companies more time to adjust and/or that board members are best suited to make such business decisions about their company.”
Shareholder proposals for racial equity audits. In 2021, following social unrest over systemic racial injustice, new shareholder proposals emerged requesting that companies oversee an independent racial equity audit. While the proposals did not win any majority votes, ISS recognizes that they did receive a significant share of support and are expected to reappear on ballots in the future.
ISS will vote on these proposals on case-by-case basis, taking into account the following factors:
- “The company’s established process or framework for addressing racial inequity and discrimination internally;
- Whether the company has issued a public statement related to their racial justice efforts in recent years, or has committed to internal policy review;
- Whether the company has engaged with impacted communities, stakeholders, and civil rights experts;
- The company’s track record in recent years of racial justice measures and outreach externally;
- Whether the company has been the subject of recent controversy, litigation, or regulatory actions related to racial inequity or discrimination; and
- Whether the company’s actions are aligned with market norms on civil rights, and racial or ethnic diversity.”
Authorization of increases in capital stock. The policy, which involves case-by-case voting on common stock authorizations, has been largely rewritten but the changes generally relate to removal of additional limitations that had been placed on authorizations for companies in the bottom 10% of TSR performance, expanding the concept of problematic use of capital to cover long-term non-shareholder approved poison pills (not just pills adopted in the past three years), and generally rearranging the policy to “better differentiate between general and specific use authorizations of capital, and to clarify the hierarchy of factors considered when problematic practices override the general ratios and that severe risks to the company’s continuation trump other concerns.” The new policy also incorporates some information from the FAQs.
ISS is removing the limitation on companies in the bottom 10% of TSR performance because companies with lower share prices are most likely the ones that will need the shares for capital raises. These companies may have suffered setbacks and need to raise funds to adopt new strategies. As a result, “while shareholders may justifiably be concerned about high levels of dilution from low-priced share issuances, in practice supporting an authorized capital increase to enable such issuances may be the least bad option for shareholders. Therefore, ISS will apply the same dilution limits to underperforming companies as are applied to other companies.”
In addition, under current policy, ISS considered only the problematic use of capital for the last three years, but that limitation excluded outstanding longer term non-shareholder approved poison pills (such as five- or ten-year pills). Under the updated policy, companies that have long-term pills that are not approved by shareholders “will be considered poor stewards of capital. This change aligns the capital authorization policy with the recommendations on directors for non-shareholder approved poison pills.”
The same changes apply to preferred stock authorizations, which have the added complications of convertibility into common stock and voting rights. The policy clarifies which features ISS considers to be problematic.
Burn-rate methodology for compensation plans. Effective for meetings held on or after February 1, 2023, ISS will use a “Value-Adjusted Burn Rate” for stock plan evaluations, which will be “based on the actual stock price for full-value awards, and the Black-Scholes value for stock options for better valuation of recently granted equity awards.” According to ISS, the “new ‘Value-Adjusted Burn Rate’ calculation will more accurately measure the value of recently granted equity awards using a methodology that more precisely measures the value of option grants. In addition, the Value-Adjusted Burn Rate is based on calculations that are more readily understood and accepted by the market: the actual stock price for full-value awards, and the Black-Scholes value for stock options.”
