A Proxy Season Guide to 2020
by David J. Lavan, P. Danielle Cortez, Christian Gonzalez
Published: January, 2020
Submission: January, 2020
The 2019 proxy season marked a year of continued changing voting behavior. Though patterns and trends of the past season do not seem to indicate changes beyond marginal impact, the 2019 season can serve to set expectations for the 2020 proxy season. From new overboarding policies to general scrutiny of shareholder proposals to new securities laws updates and business developments, public companies must ensure they are up to date in an era when proxy statements are often used as the major communication mechanism to their shareholders and the public. The following is a review of the 2019 proxy season, along with a summary of new and anticipated changes that may impact reporting and disclosure requirements for the 2020 proxy season.
2019 IN REVIEW
Despite the angst surrounding ESG topics, 2019 saw little change in average rates of shareholder support – down two points from 2018 to 2019, along with the lowest volume of shareholder proposals in the past five years. However, investor concern continued to place greater importance on a wider range of topics, including the aforementioned ESG issues, proposals on say-on-pay, accountability of boards of director elections, executive compensation, independent board chairs, and board diversity. Opposition votes on say-on-pay proposals increased in 2019, with around 14 percent of such proposals receiving less than 80 percent support, levels which have not been seen since immediately after the financial crisis. In 2019, the emphasis placed on board diversity resulted in the highest proportion of newly added female directors on record. Overall, for the third consecutive year, environmental and social proposals outnumbered governance proposals, as the breadth of governance topics addressed by shareholders is narrowing, and the range of E&S issues continues to expand to encompass topics such as climate change, as well as the increase of political spending resolutions in advance of the 2020 presidential election.
Institutional investors continued to focus their attention and efforts on board composition, long-term performance and sustainability, and environmental and social issues. The focus on board composition included topics such as supermajority voting provisions, but the big shift has been toward diversification, as well as opposition by institutional investors to director “overboarding” – the idea that directors should not serve in that capacity for too many public companies. Institutional investors continued to tighten their overboarding policies, or adopted new policies to deter overboarding, as they argue overboarded directors lack sufficient time to dedicate to their roles and is an impediment to a director’s ability to focus on each board’s requirements. Generally, institutional investors allow a board member to sit on anywhere between two and six boards. These policies deviate from Institutional Shareholder Services (ISS) and Glass Lewis, & Co. (Glass Lewis), and the number of board seats permitted by a certain director is generally dependent on whether the director is an independent director, the CEO, or a named executive officer.
Though each year, and each proxy season, brings some level of change, the 2019 season brought a significant divide in the voting trends between institutional and retail investors, demonstrating the importance of companies engaging with all shareholders, especially given the fact retail shareholders were less supportive of shareholder proposals than institutional investors but more supportive of directors who failed to receive majority support. Despite this divide, both institutional and retail investors continued the focus and pressure on companies regarding diversity issues, such as gender pay gaps and diversification of boards. Given the interest in such topics, this theme is likely to intensify this year in light of the upcoming 2020 presidential election.
2020 IN PROCESS
Dodd-Frank Hedging Disclosure Rule
The disclosure must state the category of employees covered by the policy and/or procedures, and if a company does not have any policies or practices regarding hedging, it must disclose that fact and whether hedging transactions are permitted.
The hedging disclosure requirement extends beyond the pre-existing requirement that the compensation discussion and analysis (CD&A) address hedging policies affecting the executive officers, whose compensation is required to be disclosed in an annual meeting proxy statement to the extent material to a discussion of their compensation. The new requirement mandates disclosure of hedging policies with respect to all employees, officers, and directors, whether or not material to their compensation.
The new disclosure requirement is another of the SEC’s “name or shame” rules not requiring the adoption of anti-hedging policies but requiring a company that does not have an anti-hedging policy to so state or to state that hedging transactions generally are permitted. Further in this regard, note both ISS and Glass Lewis, in addition to certain influential institutional investors, are supportive of executive anti-hedging policies.
Critical Audit Matters (CAMs)
(1) relates to accounts or disclosures material to the financial statements, and
(2) involves especially challenging, subjective, or complex auditor judgment.
The CAM disclosure rules apply to auditor reports related to:
(1) fiscal years ending on or after June 30, 2019 for large accelerated filers, and
(2) fiscal years ending on or after Dec. 15, 2020 for all other companies required to file auditor reports. Once the CAM disclosures apply to a company, all auditor reports are required to include disclosure of any CAMs or alternatively a statement from the auditor that no CAMs exist for the period under audit.
To reduce the potential for surprise and think through possible disclosure issues, we encourage companies to engage their auditors early about their process for identifying potential CAMs. Further, early notice from the auditor about potential CAMs will enable companies to determine whether anticipated CAM disclosure in the audit report should drive additional disclosure in their Form 10-K, including management’s discussion and analysis and the notes to the financial statements.
Pay Ratio Disclosure
A review of the last two proxy seasons suggests while the pay ratio disclosure has not necessarily impacted employee compensation, the disclosures can provide newspaper headlines that affect employee morale, customer choices, and potentially legislation targeting executive pay. For example, San Francisco voters will vote this November on a “CEO pay tax,” while Washington and five other states are considering similar measures. Such bills look to add a surcharge to a local business tax for companies when the CEO makes at least 100 times as much as a median employee.
Board Diversity: Compliance and Disclosure Interpretations (C&DIs)
This push for diversity on boards has led to concrete change. The Wall Street Journal reported as of summer 2019, there were no longer any S&P 500 companies with all-male boards, and ISS reported there is a record number of members of ethnic minorities becoming directors, though the rate of this change is slower than the rate of change in gender diversity. The push for diversity can also be seen in Congress. On the same day the SEC’s Division of Corporation Finance released the aforementioned C&DIs, the “Improving Corporate Governance Through Diversity Act of 2019” was introduced in both houses of Congress. The bill seeks to require public companies to disclose in their proxy statements data regarding the gender, race, ethnicity, and veteran status of their directors and nominees, as well as senior executive officers. The bill was passed in the U.S. House of Representatives on Dec. 12, 2019 and will go before the Senate in 2020.
SEC Issues Interpretative Guidance on Shareholder Proposal No-Action Request Procedure Changes
Division of Corporation Finance Issues Additional Proposal Guidance
Finally, given the SEC’s recent focus on accurate reporting of perquisites (or perks), as evidenced by the recent increase in SEC enforcement actions related to perk disclosures, companies should pay particular attention to perk disclosures. To ensure accurate disclosure of perks in 2020 statements, companies should review the SEC’s “integrally and directly related” standard for reporting perks, especially those tasked with preparation of CD&As.
PROXY ADVISORY FIRM UPDATES
Board of Directors – Voting on Director Nominees in Uncontested Elections: ISS clarified a “new nominee” could include a director who had been appointed by the board to fill a vacancy and thus had technically already served on the board. ISS also clarified only new nominees who have served for less than a year may be excused from responsibility for problematic governance issues, meaning ISS will consider them on a case-by-case basis.
Board of Directors – Board Gender Diversity: ISS, as well as most institutional investors, remain focused on board gender diversity. ISS will recommend against nominating committee chairs at Russell 3000 and S&P 1500 companies when there are no women directors, absent certain mitigating factors. A company with an all-male board may qualify for a mitigating factor if it shows a firm commitment to appoint one woman director within a year. Companies should note this mitigating factor will only be around through 2020.
Board Accountability – Problematic Governance Structure – Newly Public Companies: ISS provided a specific and updated list of bylaw or charter provisions it believes to be materially adverse to shareholders, including, without limitation, provisions such as supermajority vote requirements to amend the bylaws or charter, a classified board structure, and other “egregious provisions.” A reasonable sunset to these provisions would be a mitigating factor.
Independent Board Chair – Shareholder Proposals: ISS updated its list of factors to take into account when recommending a vote for shareholder proposals requiring the chair of the board be independent. Most notably, ISS will not take into consideration the “rationale” for the shareholder proposal. In addition, ISS added the following, non-exhaustive, specific factors that will increase the likelihood of a recommendation to vote for an independent chair shareholder proposal: a weak or poorly defined lead independent director role that fails to serve as an appropriate counterbalance to a combine CEO/chair role; the presence of an executive or non-independent chair in addition to the CEO; a “material governance failure”; and evidence the board has failed to intervene when management’s interests are contrary to shareholders’ interests.
In its publication, ISS also addresses: (i) Exemptions for new nominees, (ii) Board Composition – Attendance, (iii) Board Accountability – Restrictions on Shareholders’ Rights, (iv) Share Repurchase Programs, (v) Equity-Based and Other Incentive Plans – Evergreen Provision, and (vi) Diversity – Gender Pay Gap.
A copy of the full ISS 2020 Proxy Voting Guidelines Updates, in the form of an executive summary, is available here.
Glass Lewis Updates
Governance Structure and the Shareholder Franchise – Exclusive Forum: Glass Lewis clarified its policy to make exceptions when the exclusive forum provision is narrowly crafted to suit the company’s unique circumstances or if it includes a reasonable sunset provision. This updates their policy, which previously recommended voting against the governance committee chair when a company has adopted an exclusive forum provision without shareholder approval.
Nominating and Governance Committee – Excluded Shareholder Proposals: Glass Lewis adopted a new policy where it will generally recommend voting against all members of the governance committee when the SEC staff declines to state a view on a company’s no-action request and when the company excludes the shareholder proposal from its proxy materials. When the SEC staff orally responds to a company’s no-action request, Glass Lewis expects the company to provide some disclosure concerning the no-action relief in its proxy statement. When the company chooses to exclude a proposal from its proxy materials without such disclosure, it will generally recommend against all members of the governance committee.
Election of Directors – Compensation Committee Performance: Glass Lewis codified additional factors it will consider when evaluating the performance of compensation committee members, including recommending against all members of the compensation committee when the board adopts a frequency for its advisory vote on executive compensation other than the frequency approved by a plurality of shareholders.
In its update, Glass Lewis also made clarifying amendments to its:
(i) Board Attendance policy,
(ii) Company Responsiveness to Low Say-on-Pay Vote,
(iii) Say-on-Pay Frequency,
(iv) Supermajority Voting Shareholder Proposals,
(v) Gender Pay Equity Shareholder Proposals, and
(vi) Contractual Payments and Arrangements, along with several minor housekeeping edits, including the removal of several outdated references, to enhance clarity and readability.
A copy of the full Glass Lewis 2020 Proxy Paper Guidelines is available here.
OTHER SECURITIES LAW DEVELOPMENTS
New Disclosure Simplification Rules Adopted
SEC Proxy Advisory Firm Guidance
There was also an increase in the first half of the year of the amount of investors creating sustainability data systems to aid in investment purposes. The systems are created around sustainability ratings and are intended to evaluate and incorporate environmental and social factors throughout the investment cycle to strategically leverage ESG data in aiding investors in investment decision-making. This is an attempt to address the lack of consistency in companies’ ESG reports and disclosures and the resulting inability of companies to properly benchmark against their peers. In fact, while nearly all S&P 500 companies provided some form of ESG or sustainability reports in 2019, there is still concern by stakeholders regarding the quality, comparability, and usefulness of these reports. These sustainability data systems will continue to aid investors throughout the 2020 proxy season and could lead to an increase in stakeholder demands for more transparent and higher quality ESG reporting.
The 2020 proxy season will also likely continue to bring complexity as investors continue digging further into compensation plans. Further, while data privacy and cybersecurity were not on the forefront in the proxy advisory firm updates or SEC guidance, new data privacy laws such as the General Data Protection Regulation in the European Union may spur shareholders to submit more proposals of this type going forward, particularly if investors believe disclosures made by companies on issues relating to cybersecurity and/or data privacy are outdated, overly generalized, or otherwise lacking. As we saw with two of Amazon’s proposals in 2019, one potential subject of these anticipated proposals might focus on facial recognition, particularly regarding fraud prevention and security.
To prepare for the 2020 proxy season, companies should review the new rules and trends and take inventory of their base, policies, and procedures. It will likely prove useful to reassess proxy disclosures in the key areas of interest to shareholders and promote engagement with company shareholders. Remember, what companies do in their proxy off-season is as important as what they do during their proxy season.
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