The following are some important reminders and updates for the 2017 proxy season.
Required Vote in 2017
The Securities and Exchange Commission (SEC) requires companies to conduct a shareholder advisory vote at least once every six calendar years to give shareholders the opportunity to express a view on how often the company should hold its say-on-pay vote. Companies that first conducted a "say-when-on-pay" vote in 2011 (and that have not conducted a subsequent vote) will need to include a say-when-on-pay proposal in their 2017 proxy statement. Shareholders must be given four options: to vote for a frequency of every one, two, or three years, or to abstain from voting. Although companies may include a recommendation as to how shareholders should vote, the company must make clear that (1) shareholders are not voting to approve or disapprove the company's recommendation; and (2) the results of the say-when-on-pay vote are not binding on the company or its board of directors (as is true of the results of the say-on-pay vote). Companies are also required to disclose in their proxy statement the current frequency of the say-on-pay vote and when the next scheduled say-on-pay vote will occur.
Form 8-K Requirement
Within four business days of the date of the annual meeting, companies must disclose the results of their say-when-on-pay vote in their Form 8-K containing the results of the meeting. Companies must also disclose their decision with respect to how often they will hold the say-on-pay vote, regardless of whether that decision is consistent with the frequency chosen by shareholders. We recommend that companies that have made a final decision regarding the frequency of their say-on-pay vote include that decision in the same Form 8-K. If the decision is made after the Form 8-K is filed, companies must amend their previously filed Form 8-K to disclose how often they will hold a say-on-pay vote no later than 150 days after the vote, but in no event later than 60 days prior to the deadline for submission of Rule 14a-8 shareholder proposals. Failure to report the company's decision on Form 8-K will result in a loss of Form S-3 eligibility for 12 months.
Emerging growth companies (EGCs) are exempt from the say-on-pay and say-when-on-pay votes. Once an EGC ceases to qualify as an EGC, it must hold its first say-on-pay1 vote by no later than the first anniversary of the date on which it ceases to so qualify (or, if the EGC qualified for less than two years after it went public, by no later than the third anniversary of the date it went public).
Third-Party Compensation of Directors or Nominees of Nasdaq-Listed Companies
Nasdaq Rule 5250(b)(3) requires companies to make annual disclosure of the material terms of agreements or arrangements between directors or director nominees and third parties that relate to compensation or other payment in connection with that person's candidacy or service as a director. A company must make these disclosures no later than the date on which it files its proxy statement in connection with its next shareholder meeting at which directors are elected. If a company does not file proxy statements, it must disclose third-party compensation agreements no later than when it files its next Form 10-K. Companies may make these disclosures via their websites so long as the posting is made on or before the date the proxy statement (or the Form 10-K, if applicable) is filed and the information is continuously accessible.
Proxy Card Proposal Descriptions
The SEC recently reminded companies of the need for proxy cards to clearly identify and describe the specific action on which shareholders will be asked to vote. Generic descriptions are not acceptable. This guidance applies to both management and shareholder proposals.
Director Election Standards
The SEC is encouraging companies to take a fresh look at the descriptions of their director election standards in proxy statements after finding numerous inconsistencies and ambiguities. Companies should ensure that the descriptions of all of their voting standards correctly describe their governing documents and state law.
Audit Committee Reports
Item 407(d)(3)(i)(B) of Regulation S-K requires an audit committee to certify in its report that it has discussed with its independent auditors certain matters originally set forth in Accounting Standards No. 61. The Public Company Accounting Oversight Board has reorganized its Accounting Standards, and this reference should now be to Accounting Standards No. 1301.
Proxy Advisor Policy Updates
Both Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis) recently updated their voting policies. ISS's updates (available here) became effective on February 1, 2017, and Glass Lewis's updates (available here) became effective on January 1, 2017.
ISS Policy Updates
Restrictions on Shareholder-Initiated Bylaw Amendments
ISS will now generally recommend a vote against nominating and corporate governance committee members of companies that have provisions in their certificate of incorporation that impose undue restrictions on the ability of shareholders to amend the company's bylaws. Examples of undue restrictions include (1) outright prohibitions on amending bylaws; and (2) share-ownership or time-holding requirements in excess of those outlined by Rule 14a-8.
Governance at Newly Public Companies
At newly public companies, ISS will now generally recommend a vote against all directors, except new nominees (who will be considered on a case-by-case basis) who, prior to or in connection with the company's initial public offering, adopted charter or bylaw provisions materially adverse to shareholder rights or implemented a multi-class capital structure in which the classes have unequal voting rights. Unless the adverse provision or multi-class capital structure is reversed or removed, ISS will evaluate subsequent director nominees on a case-by-case basis. ISS will no longer give weight to a public commitment to put the provision to a shareholder vote within three years of the date of the initial public offering; instead, a sunsetting of the provision will be required.
ISS will now generally recommend a vote against any director who serves (1) on more than five public company boards; or (2) both as CEO of a public company and as a director on more than two other public company boards (besides his or her own). For overboarded CEOs, ISS will only recommend a vote against them at their outside boards. ISS's one-year transition period from its prior policy—which allowed directors to sit on up to six public company boards—ended on February 1, 2017.
Equity Plan Scorecard
ISS made undisclosed modifications to the weighting of factors in its proprietary Equity Plan Scorecard and added "Dividends payable prior to award vesting" to the "Plan Features" category. In order to receive full credit under this new factor, a company must expressly prohibit the payment of dividends on unvested awards until vesting occurs. Under the "Lack of minimum vesting period for grants made under the plan" component of "Plan Features," a minimum vesting period of one year, applicable to all plan awards, is required for full points.
Amendments to Incentive Plans for 162(m) Purposes
ISS will now generally support proposals to amend cash or equity incentive plans if the proposal seeks approval for Section 162(m) purposes only. However, ISS will generally recommend a vote against these proposals if the committee administering such plan does not consist entirely of independent outsiders. All other proposals amending cash or equity incentive plans will be evaluated on a case-by-case basis.
New Factors Used to Assess Director Compensation Proposals
ISS has implemented a new policy for the evaluation of director compensation proposals that includes assessment of the following qualitative factors:
the relative magnitude of director compensation as compared to peer companies;
the presence of problematic pay practices relating to director compensation;
director stock ownership guidelines and holding requirements;
equity award vesting schedules;
the mix of cash and equity-based compensation;
meaningful limits on director compensation;
the availability of retirement benefits or perquisites; and
the quality of disclosure surrounding director compensation.
The policy will be applied on a case-by-case basis.
Equity Plans for Nonemployee Directors
ISS clarified and broadened the factors evaluated in connection with nonemployee director equity plans. The amended policy replaces a weighted evaluation with a holistic consideration of all relevant factors, including those applicable to shareholder ratification of director compensation, and will be applied on a case-by-case basis. ISS will principally consider:
the total estimated cost of the equity plan relative to peer companies;
the company's three-year burn rate relative to peer companies; and
the presence of egregious plan features, such as option-repricing provisions or liberal change-in-control vesting risk.
Glass Lewis Policy Updates
Governance at Newly Public Companies
Glass Lewis will now consider a wider variety of factors in determining whether shareholder rights are being "severely restricted indefinitely" at newly public companies, including:
the adoption of anti-takeover provisions, such as a poison pill or classified board;
supermajority vote requirements to amend governing documents;
the presence of exclusive-forum or fee-shifting provisions;
whether shareholders can call special meetings or act by written consent;
the voting standard in the election of directors;
the ability of shareholders to remove directors without cause; and
the presence of evergreen provisions in the company's equity compensation arrangements.
Where a company adopts such a measure prior to its initial public offering, Glass Lewis will continue to recommend a vote against all directors unless the company (1) commits to submitting the provision to a shareholder vote at the first shareholder meeting following the initial public offering; or (2) provides a sound rationale or sunset provision.
Glass Lewis will now generally recommend a vote against (1) any director who serves on more than five public company boards; or (2) any director who serves both as an executive officer of a public company and as a director on more than two other public company boards (including his or her own). For such overboarded executive officers, Glass Lewis will only recommend a vote against them at their outside boards. When considering a potentially overboarded director, Glass Lewis will consider factors such as:
the size and location of the other companies where the director serves;
the director's board roles at the companies in question;
whether the director serves on the board of any large privately held companies;
the director's tenure on the boards in question;
the director's attendance record at all companies; and
whether a sufficient rationale is provided by the company.
Board Evaluation and Refreshment
Glass Lewis clarified its approach to board evaluation, succession planning, and refreshment. Generally, Glass Lewis will apply a holistic review of a board's focus on alignment of directors' skills and experience with company strategy. However, where a board has adopted term or age limits and subsequently waives those limits, Glass Lewis will consider recommending that shareholders vote against a company's nominating and corporate governance committee members absent sufficiently explained mitigating circumstances.
Note on Dodd-Frank Rules
With the change in presidential administration, there has been significant commentary and uncertainty related to the possible repeal of certain Dodd-Frank provisions and rulemaking, such as pay ratio disclosure2 and conflict minerals reporting requirements. For example, Acting Chairman of the SEC Michael S. Piwowar has requested that the SEC staff seek further comment on the pay ratio rules and consider whether additional relief is appropriate from the conflict mineral rules. We caution companies not to rely on any proposed changes to the rules and requirements at this time, as the timing and extent of such changes, if any, is uncertain.
1 The JOBS Act is silent as to when the first say-when-on-pay vote must be held after EGC status ends and does not provide the same transition period as it does for say-on-pay. Accordingly, companies may need to provide a say-when-on-pay vote before they are required to provide a say-on-pay vote.
2 Pay ratio disclosure rules were adopted by the SEC in 2015. Companies are required to provide pay ratio disclosure for their first fiscal year beginning on or after January 1, 2017.