On October 14, 2020, Institutional Shareholder Services Inc. (ISS) released for comment its proposed voting policy changes to be applied to shareholder meetings taking place on or after February 1, 2021. The proposed changes on that date included policy changes regarding (1) racial and ethnic board diversity, (2) director accountability for governance failures related to environmental or social issues, and (3) shareholder litigation rights. On November 12, 2020, ISS published their final policy changes, which in addition to the three described above, also included a number of additional policy changes and clarifications that had not been shared during the comment period. The final policy changes can be found here, and this post explores select policy changes in depth.
Racial and Ethnic Board Diversity. Beginning in the 2022 proxy season, for companies in the Russell 3000 and S&P 1500, ISS will generally recommend a vote 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 racially or ethnically diverse members. ISS did not previously have a voting policy regarding board diversity. ISS set no clear standards as to how it will determine whether there is an “apparent” lack of diversity. The policy change came primarily in response to recent social unrest surrounding racial injustices and responses from ISS policy surveys where almost 60% of investors “indicated that boards should aim to reflect the company’s customer base and the broader societies in which they operate by including directors drawn from racial and ethnic minority groups.” ISS states that an exception will be made if the company had racial 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 ethnically diverse member within a year. While this policy will not be enforced for the 2021 proxy season, ISS explained that it would showcase a lack of racial and/or ethnic diversity (or lack of disclosure thereof) in its 2021 research reports on U.S. companies in order "to help investors identify companies with which to engage and that may foster dialogue between investors and issuers on this topic." Institutional encouragement of board diversity is a growing trend over the past year. For our prior post on Nasdaq’s recent proposed listing rules aimed at advancing diversity among corporate boards, click here.
Governance Failures: Material Environmental & Social Risk Oversight Failures. ISS currently has a policy that in extraordinary circumstances it will recommend a vote against or withhold from directors individually, committee members, or the entire board, due to, among other things, “material failure of governance, stewardship, risk oversight or fiduciary responsibilities at the company.” The prior policy went on to provide examples of “risk oversight” to include bribery, large or serial fines or sanctions from regulatory bodies, significant adverse legal judgments or settlements, or hedging of company stock. For 2021, ISS’ new policy adds “demonstrably poor risk oversight of environmental and social issues, including climate change” to the list of examples of “risk oversight.” In its original proposal of the rule change, ISS explained that if a company is in a “highly impactful sector” (such term is not defined) and is not taking steps to reduce environmental and social risks that are likely to have a large negative impact on future company operations, ISS may recommend taking action against directors who fail to make their companies more resilient. ISS now has the “flexibility to find that directors have failed in their risk oversight role if they have neglected to take meaningful steps to increase the resilience of companies to climate-related risks.”
Shareholder Litigation Rights. Under its prior voting policy, ISS generally recommended a vote on a case-by-case basis on company bylaw provisions that impact shareholders' litigation rights (including exclusive venue provisions), taking into account a list of factors (including, but not limited to, the stated rationale for adopting such a provision, disclosure of past harm from shareholder lawsuits, the breadth of application of the bylaw provision, and governance features such as a shareholders’ ability to repeal the provision at a later date). ISS has updated its policy to include vote recommendations regarding federal forum selection provisions and update its existing voting policies relating to exclusive forum provisions for state law matters.
- Federal Forum Selection Provisions. Under the new policy, ISS will generally recommend a vote “for federal forum selection provisions in the charter or bylaws that specify ‘the district courts of the United States’ as the exclusive forum for federal securities law matters, in the absence of serious concerns about corporate governance or board responsiveness to shareholders.” However, ISS would generally recommend a vote against “provisions that restrict the forum to a particular federal district court.” Unilateral adoption (without a shareholder vote) of such a provision would generally be considered a one-time violation of ISS’ policy against unilateral bylaw or charter amendments and could result in a recommendation for a vote against directors.
- Exclusive Forum Provisions For State Law Matters. Under the new policy, ISS will generally recommend a vote for “charter or bylaw provisions that specify courts located within the state of Delaware as the exclusive forum for corporate law matters for Delaware corporations, in the absence of serious concerns about corporate governance or board responsiveness to shareholders.” For exclusive forum provisions that affect shareholders’ litigation rights and specify states other than Delaware, similar to the existing rule, ISS will make its voting recommendations on a case-by-case basis, taking into account factors such as those described above. Where the provision identifies as the exclusive forum for corporate law matters a state other than the state of incorporation or that specify a particular local court within the state, ISS will generally recommend a vote against those provisions.
The distinction is made with regard to Delaware because ISS recognizes that Delaware has a separate court system specializing in corporate law cases with a large body of associated precedent, and thus the likelihood of a speedy and efficient resolution of Delaware corporate law cases is considered greater if they are heard in Delaware courts. ISS also observes that one potential hitch to the bifurcation of federal forum provisions and exclusive forum provisions related to state corporate law is that to the extent that a company has, in addition to an exclusive federal forum provision, a separate exclusive forum provision for state corporate law claims, plaintiffs could be prevented from bringing cases alleging both types of claims in the same court.
In addition to the three policy changes described above, ISS also implemented certain other policy changes, including:
- Gender Diversity – ISS is eliminating transitional language that permitted a company that previously did not have a female director to make a commitment to add a female director by February 2021. Effective February 2021, companies with no women on their board will receive an adverse vote recommendation. An exception will only be made if there was at least one woman on the board at a prior board meeting and the board commits to restoring its gender diversity by the next annual meeting.
- Advance Notice Requirements – ISS now recommends a vote in favor of proposals for advance notice provisions that require notification 120 days prior to the meeting. Under the prior policy, notice could not be required earlier than 60 days prior to the meeting.
- Term Limits – ISS is updating its policy on term limits, but will continue to recommend against age limits (because they are arbitrary and imply an impairment solely due to age). Under the new policy, ISS will consider recommendations of term limits on a case-by-case basis, taking into consideration certain factors including the rationale provided for adoption of the term limit, the robustness of the company’s board evaluation process, whether the limit is of sufficient duration to allow for a broad range of director tenures, would disadvantage independent directors or will be imposed by the board evenly, without the ability to waive it in a discriminatory manner.
- Virtual Meetings – ISS will generally support management proposals that allow shareholder meetings to be convened virtually as long as they do not preclude in-person meetings. With regard to shareholder proposals concerning virtual-only meetings, ISS will recommend a vote on a case-by-case basis, considering the scope and rationale of the proposal.
 Proposed ISS Benchmark Policy Changes for 2021 Request for Comments, dated October 14, 2020, available here.