In the latest instance of proxy advisors establishing a governance standard without offering evidence that it will improve corporate governance or corporate performance, ISS has adopted a new policy position that appears designed to chill board efforts to protect against “golden leash” incentive bonus schemes. These bonus schemes have been used by some activist hedge funds to recruit director candidates to stand for election in support of whatever business strategy the fund seeks to impose on a company.
Posts Tagged ‘Trevor Norwitz’
Institutional Shareholder Services Inc. (ISS) recently published its 2014 Corporate Governance Policy Updates, which would apply to annual meetings beginning in February 2014. ISS updated relatively few of its policies this year, but the changes largely represent a more measured, company-specific approach to corporate governance practices, which reflects a move by ISS to avoid “one-size-fits-all” policies and recommendations. ISS also announced a new consultation and comment period concerning potential policy changes applicable to the 2015 proxy season or beyond with respect to director tenure, director independence, independent chair shareholder proposals, equity-based compensation plans and auditor ratification.
2014 Policy Updates
Board Response to Majority Supported Shareholder Proposals. As announced last year, ISS evaluates a company’s response to shareholder proposals that receive a majority of shares cast in considering “withhold” recommendations against the full board, committee members or individual directors. With respect to such majority supported shareholder proposals, ISS will now make vote recommendations on director elections on a case-by-case basis and will no longer require boards to fully implement majority supported shareholder proposals in all cases. Instead, ISS will consider mitigating factors in cases involving less than full implementation, including the board’s articulated rationale for its response and level of implementation (with consideration of such rationales being a new factor not previously considered by ISS), disclosed shareholder outreach efforts by the board in the wake of the vote, the level of support and opposition for the proposal, actions taken, and the continuation of the underlying issue as a voting item on the ballot (as either shareholder or management proposals).
ISS Proxy Advisory Services recently recommended that shareholders of a small cap bank holding company, Provident Financial Holdings, Inc., withhold their votes from the three director candidates standing for reelection to the company’s staggered board (all of whom serve on its nominating and governance committee) because the board adopted a bylaw designed to discourage special dissident compensation schemes. These special compensation arrangements featured prominently in a number of recent high profile proxy contests and have been roundly criticized by leading commentators. Columbia Law Professor John C. Coffee, Jr. succinctly noted “third-party bonuses create the wrong incentives, fragment the board and imply a shift toward both the short-term and higher risk.” In our memorandum on the topic, we catalogued the dangers posed by such schemes to the integrity of the boardroom and board decision-making processes. We also noted that companies could proactively address these risks by adopting a bylaw that would disqualify director candidates who are party to any such extraordinary arrangements.
ISS, the dominant proxy advisory firm, recently unveiled its new ISS Governance QuickScore product, which will replace its Governance Risk Indicators (“GRId”) next month. ISS asserts that QuickScore is an improvement on the GRId product because it is “quantitatively driven” (with a “secondary policy-based overlay”). Using an algorithm purportedly derived from correlations between governance factors and financial metrics, QuickScore will rank companies in deciles within each of ISS’ existing four pillars—Audit, Board Structure, Compensation and Shareholder Rights – and provide an overall governance rating to “provide a quick understanding of a company’s relative governance risk to an index or region.” While one can understand, as a business matter, ISS’ desire to continually reinvent and “improve” its products, the constant shifting of goalposts creates uncertainty and inefficiency. More important, QuickScore will likely provide a no more complete or accurate assessment of corporate governance practices than its predecessors, and it may be worse.
When ISS adopted its GRId product three years ago, we cautiously noted that it offered greater transparency and granularity than the blunt one-dimensional CGQ ratings that it replaced. Unfortunately, in our view, going back to a system of opaque quantified ratings is a move in the wrong direction. After a substantial investment of management time and effort, companies have familiarity with the GRId “level of concern” approach, which at least helps them understand and address any legitimate issues or explain any divergences from ISS’ “best practices.” While ISS retains GRId’s formulaic approach, to the extent that it does not share the weightings it assigns to the various governance factors, it reduces transparency as companies would not be able to compute their own QuickScores.
In a second Chancery transcript ruling on the subject in recent weeks, Chancellor Leo E. Strine, Jr. has made clear that Delaware has no per se rule against “Don’t Ask, Don’t Waive” standstill provisions (which prohibit a party subject to a standstill, including a losing bidder in an auction, from requesting a waiver from its standstill obligations). The Chancellor also provided guidance for using such a provision as an “auction gavel” to secure the best price reasonably available to a target company involved in a sales process. The ruling in In Re Ancestry.com is a welcome clarification that will help maintain the vitality of auctions where a target wants to incentivize bidders to come forth with their highest bid.
A recent transcript ruling in the Delaware Court of Chancery could have a significant impact on the market for control of public companies, particularly in an auction context, if broadly adopted.
Vice Chancellor Laster’s bench decision in In Re Complete Genomics, Inc. Shareholder Litigation questions the enforceability of a standstill agreement that prohibits the bidder from privately requesting a waiver to make a topping bid, which he labeled a “Don’t Ask, Don’t Waive” standstill. The Vice Chancellor did not object to the bidder being prohibited from publicly requesting a waiver (which he understood would clearly circumvent the standstill), but held that directors have a continuing duty to be informed of all material facts, including whether the rejected bidder is willing to offer a higher price. By analogy to cases holding that a board that has agreed to sell the company may not close its ears to the possibility of higher bids, he suggested that “a Don’t Ask, Don’t Waive Standstill is impermissible because it has the same disabling effect as the no-talk clause, although on a bidder-specific basis.” While this may seem favorable for bidders, it raises questions about the protections afforded by typical standstill arrangements and the willingness of targets to engage in transaction discussions if they have doubts about those protections. The ruling also raises questions about its potential extension to standstill agreements in joint ventures and other commercial contexts, which could undermine the value of contractually bargained-for protections.
Institutional Shareholder Services has released its 2013 Corporate Governance Policy Updates, which represent a more moderate approach than the proposals it released for comment in October. These changes, which will generally apply for the 2013 proxy season, continue the trend of narrowing director discretion in matters traditionally considered to be within directors’ authority. In addition, ISS’ expansion into social policy matters appears often to be at odds with shareholder and corporate interests and is far more likely to benefit special interest groups. It should be noted, though, that ISS took into account many of the comments it received and in some cases moved from a one-size-fits-all approach to a more appropriate case-by-case analysis. Although it is important that boards of directors be cognizant of ISS voting policies, it is essential that, in their decision-making, directors carefully consider the best interests of the corporations they serve and not merely defer to shareholder advocacy groups.
A small but influential alliance of activist investor groups, academics and trade unions continues — successfully it must be said — to seek to overhaul corporate governance in America to suit their particular agendas and predilections. We believe that this exercise in corporate deconstruction is detrimental to the economy and society at large. We continue to oppose it.
The Shareholder Rights Project, Harvard Law School’s misguided “clinical program” which we have previously criticized, today issued joint press releases with eight institutional investors, principally state and municipal pension funds, trumpeting their recent successes in eliminating staggered boards and advertising their “hit list” of 74 more companies to be targeted in the upcoming proxy season. Coupled with the new ISS standard for punishing directors who do not immediately accede to shareholder proposals garnering a majority of votes cast (even if they do not attract enough support to be passed) — which we also recently criticized — this is designed to accelerate the extinction of the staggered board.
Activist investors continue to aggressively exploit a variety of techniques — including hedging, securities borrowing, total return swaps and other contractual arrangements — to avoid public disclosure of their investments and to obtain governance rights out of proportion with their economic stakes. We have long warned against these abuses, which are not confined to the U.S. market but are truly a global phenomenon. Courts, including the Supreme Court of Delaware, have emphasized that corporate voting rights and economic interests should not be “uncoupled” but should travel together. The SEC is considering regulating the use of derivatives in its “proxy plumbing” initiative, and we have encouraged it to focus on “empty voting” abuses.
A recent case in Canada illustrates the problems with the current system. In TELUS Corp. v. CDS Clearing and Depository Services Inc., a U.S.-based hedge fund, Mason Capital, amassed a voting position of almost 20% in TELUS, a Canadian telecommunications provider with a dual-class capitalization. Mason hedged its entire position by shorting TELUS’s non-voting shares. Although Mason was the company’s largest voting shareholder, it would be unaffected whether TELUS shares increased or decreased in value, but rather stood to profit if the price differential between the voting shares and the non-voting shares widened. Mason used its (empty) voting position to defeat TELUS’s plan to collapse its dual class share structure, and sought to call a shareholder meeting to approve resolutions requiring a minimum premium for any conversion of non-voting shares into voting common, which would be advantageous for Mason, but not necessarily for other shareholders whose economic interests are aligned with their voting rights.
Testifying recently before a House Financial Services subcommittee, SEC Chairman Mary Schapiro stated that, because of capacity constraints, proposing a revised mandatory rule on shareholder access to company proxy materials is “not on the Commission’s immediate agenda.” She noted, however, that the issue is one that the SEC will “continue to look at over time.”
Last summer, the D.C. Circuit Court of Appeals vacated the SEC’s Rule 14a-11, finding that the SEC had “acted arbitrarily and capriciously” in adopting the rule without adequately assessing its economic effects. At the time, the SEC said that it was considering its options but noted that its changes facilitating private ordering in proxy access were not impacted by the Court’s decision.
In the current 2012 proxy season, less than two dozen companies have received proxy access proposals. This modest level of activity is in part explained by activist shareholders waiting to learn whether or not the SEC would be re-promulgating a mandatory rule. Because it is now clear that this will not happen, at least not for the 2013 proxy season, we can expect the focus on private ordering through shareholder proposals to continue and increase.