United States: ISS Releases New Benchmark Policies For 2021

Yesterday, ISS released its new benchmark policies, effective for shareholder meetings on or after February 1, 2021. In addition to anticipated policy changes (see this PubCo post) regarding board racial and ethnic diversity, shareholder litigation rights (such as exclusive federal forum provisions) and director accountability for governance failures related to environmental or social issues, ISS also made a number of other policy changes and clarifications, not previewed during the comment period, that generally relate to changing market practices, certain shareholder proposals and policies that were announced previously but subject to a transition period.

ISS reports that, in response to its online policy survey, it received 522 responses, including from 176 investors and related organizations and 346 non-investors, of which 258 represented organizations based in the U.S. ISS also held five roundtables in the U.S. related to board and shareholder rights, compensation and environmental and social shareholder proposals. In response to its request for comment on proposed policy changes, ISS received feedback in English from 23 commenters, including institutional investors and non-investors, such as corporate issuers, non-profit organizations, special-interest trade associations, law firms and others. ISS also notes that, in April, it issued special guidance related to COVID-19 (see this PubCo post) and pandemic-related pay decisions (see this PubCo post).

Board Diversity. ISS has not previously had a voting policy regarding board racial or ethnic diversity, but notes that, in light of recent social unrest triggered by racial and ethnic injustices and inequality, "[m]any investors have expressed interest in seeing ethnic or racial diversity on boards, citing reasons of equality and good corporate governance." In response to the ISS policy survey, almost 60% of investors

In support of its new policy, ISS points to different obstacles to increasing racial and ethnic representation on boards, discussed in the "Black Corporate Directors Time Capsule Project" (see this PubCo post), including problems associated with recruiting directors primarily through social networks, as well as the recruiting pipeline in which Black executives are "disproportionately in support roles versus senior executives in so-called "profit and loss jobs." (See this PubCo post.) Relative to strides being made in board gender diversity, racial and ethnic board diversity has not kept pace (see this PubCo post); however, it has more recently become a board priority. In addition, ISS notes that AB 979, which mandates the representation on boards of "underrepresented communities," has been signed into law in California (see this PubCo post). ISS also highlights recent remarks by SEC Commissioner Allison Lee advocating that the SEC do more to mandate diversity disclosure (see this PubCo post), SEC required board diversity disclosure (see this PubCo post) and initiatives undertaken by institutional investors groups (see this PubCo post).

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New California legislation, AB 979, should work in tandem with the new ISS voting policy.  Like California's 2018 board gender diversity law, this new law will require, no later than the close of 2021, that a "publicly held corporation" (that is, a corporation with outstanding shares listed on a major U.S. stock exchange) with principal executive offices (according to its Form 10-K) located in California, no matter where it is incorporated, have a minimum of one director from an "underrepresented community."  A director from an "underrepresented community" means a director who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, Alaska Native, gay, lesbian, bisexual, or transgender.  A corporation may increase the number of directors on its board to comply with the new law.

No later than the close of 2022, a corporation with more than four but fewer than nine directors will be required to have a minimum of two directors from underrepresented communities, and a corporation with nine or more directors will need to have a minimum of three directors from underrepresented communities.  As with board gender diversity, the bill will likely have the effect of  compelling companies to look outside their traditional channels to find new directors from underrepresented communities.  (See this PubCo post.) 

Under the new policy, which applies to companies in the Russell 3000 or S&P 1500, for 2021, the absence of racial/ethnic diversity will not be a factor in voting recommendations, but ISS will highlight in its research reports those boards that lack racial and/or ethnic diversity "to help investors identify companies with which to engage." The press release notes that "[a]ggregate diversity statistics provided by the board will be considered if they are specific to racial and/or ethnic diversity." 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." However, 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."

Director Accountability for Governance Failures. Currently, ISS voting policy provides that ISS will recommend, under extraordinary circumstances, a vote against or withhold from directors individually, committee members or the entire board, in the event of, among other things, material failures of governance, stewardship, risk oversight or fiduciary responsibilities at the company. Examples of risk oversight failures include bribery, large or serial fines or sanctions from regulatory bodies, significant adverse legal judgments or settlements, or hedging of company stock. Under the new policy, ISS is adding to that list of failures "demonstrably poor risk oversight of environmental and social issues, including climate change." It remains to be seen how ISS will apply that policy.

ISS observes that most commenters supported this change,

However, an "industry group for smaller companies in the UK urged ISS not to hold small and mid-sized companies to the same standards regarding climate risk oversight as those for larger companies."

Shareholder Litigation Rights.  Currently, ISS voting policy provides for a case-by-case analysis of bylaws that impact shareholders' litigation rights, taking into account a variety of factors.  Under the new policy, ISS will take a more nuanced view of these types of provisions, distinguishing among federal securities law matters, Delaware corporate law matters for Delaware corporations, and corporate law matters for other states.

ISS explains that the need for a new policy regarding federal forum provisions was occasioned by the decision in March 2020 of the Delaware Supreme Court, overturning the Chancery Court, holding exclusive federal forum provisions to be facially valid under Delaware law.  As a result, some companies began again to include these provisions in their governing documents, which "necessitates a new policy on these new voting items and provides an opportunity to re-examine the existing policy on exclusive forum provisions for state law matters and to reorganize the entire litigation rights section for clarity."

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As noted above, in Salzberg v. Sciabacucchi (pronounced Shabacookie), the Delaware Supreme Court unanimously held that charter provisions designating the federal courts as the exclusive forum for '33 Act claims are "facially valid." (See this PubCo post.) After Sciabacucchi, the question became whether exclusive federal forum provisions (FFPs) would be enforceable in the courts of other states. Given that Sciabacucchi involved a facial challenge, the Delaware Supreme Court had viewed the question of enforceability as a "separate, subsequent analysis" that depended "on the manner in which it was adopted and the circumstances under which it [is] invoked." If challenged in the courts of other states, the Delaware Supreme Court said that there were "persuasive arguments," such as due process and the need for uniformity and predictability, that "could be made to our sister states that a provision in a Delaware corporation's certificate of incorporation requiring Section 11 claims to be brought in a federal court does not offend principles of horizontal sovereignty," and should be enforced. But how would other states view the issue?  

In an apparent case of first impression, one such case was recently decided in the San Mateo Superior Court in California, Wong v. Restoration Robotics (18CIV02609, Sept. 1, 2020). In that case, the Court, exercising its discretion, declined "jurisdiction over the claims alleged against Restoration Robotics and its officers and directors only, pursuant to the FFP." As the Court set the stage, "the holding by the Delaware Supreme Court that the provision is allowable under Delaware law.is basically irrelevant to our case. Our issue is whether the Federal Forum Provision is legal and enforceable under California law and/or under Federal law."  In the Court's analysis, the defendants had shown that the FFP was mandatory, that it restricted "all Securities Act claims to federal court, without limitation on venue." The FFP was also "subject to [a] shareholder vote and approval, and was not applied retroactively.. Accordingly, the burden of proof shifted to the Plaintiffs to demonstrate that the FFP is unenforceable, unconscionable, unjust or unreasonable," a burden that the plaintiffs could not meet. Similarly, the Court held that the FFP was not illegal under California law, nor did it violate any California statute or public policy. However, the Court said, the FFP could be illegal, contrary to public policy or unconscionable if it were "shown to be unconstitutional or illegal under federal law. Plaintiffs had a heavy burden; and Plaintiffs have no federal law actually holding that the forum selection clauses are unconstitutional or illegal under federal law."  (See this PubCo post.)

Under the new policy, ISS would 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," but against provisions that select a particular federal district court as the exclusive forum.

With regard to provisions that restrict to the courts of a particular state (generally the state of incorporation) the ability of shareholders to bring derivative lawsuits for claims arising out of state corporate law, under the new policy, ISS will 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."

However, for exclusive forum provisions that affect litigation rights of shareholders and specify states other than Delaware, ISS would make its voting recommendations on a case-by-case basis, taking into account a number of factors, including whether the company has disclosed "past harm from duplicative shareholder lawsuits in more than one forum." 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 would generally recommend a vote against those provisions. 

Why distinguish Delaware? "Because," according to ISS, "Delaware has a separate court system specializing in corporate law cases, with a large body of precedent stemming from Delaware's status as the most common state of incorporation in the US, the likelihood of a speedy and efficient resolution of Delaware corporate law cases, in particular, is considered to be greater if they are heard in Delaware courts. Therefore, in the absence of concerns about abuse of the provision or about poor governance more generally, ISS will generally recommend in favor of charter or bylaw provisions designating courts in Delaware as the exclusive forum for state corporate law matters at companies incorporated in that state."

And why distinguish exclusive federal forum provisions from exclusive forum provisions related to state corporate law? Here, ISS explains that, in considering proposals to designate a company's state of incorporation as the exclusive forum for cases arising under state corporate law, "shareholders must balance the advantages (potential cost savings from eliminating duplicative litigation in more than one forum; eliminating risks of unpredictable or incorrect outcomes from courts that are unfamiliar with the law of the state of incorporation, or even unfamiliar with corporate law generally) against the disadvantages (inconvenience to plaintiffs who must bring suit in another state and hire local counsel there)." 

However, exclusive federal forum provisions offer the benefit of "eliminating duplicative litigation and ensuring that cases are heard by courts that are well-versed in the applicable law," but typically do not restrict the litigation to any particular federal district, requiring only that federal securities litigation be brought in federal district courts anywhere in the U.S. As a result, plaintiffs have the ability to select the state in which to file, and are typically not seriously inconvenienced.  Nevertheless, ISS observes, one potential hitch 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.

Fee-shifting provisions in the charter or bylaws require a shareholder who sues a company unsuccessfully to pay all litigation expenses of the defendant corporation and its directors and officers. ISS generally recommends a vote against provisions that mandate fee-shifting when plaintiffs are not completely successful on the merits (i.e., including in cases where the plaintiffs are partially successful).  

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In 2015, Delaware amended the Delaware General Corporation Law to invalidate, in Delaware charters and bylaws, fee-shifting provisions in connection with internal corporate claims. "Internal corporate claims" are claims, including derivative claims, that are based on a violation of a duty by a current or former director or officer or stockholder or as to which the corporation law confers jurisdiction on the Court of Chancery. These claims include claims arising under the DGCL and claims of breach of fiduciary duty by current or former directors or officers or controlling stockholders of the corporation, or persons who aid and abet those breaches. However, as discussed in this PubCo post, federal securities class actions are not included. The amendments also expressly authorized the adoption of exclusive forum provisions for internal corporate claims, as long as the exclusive forum is in Delaware. (See this PubCo post.)

Currently, if provisions are added unilaterally by the board, ISS generally recommends a vote against or withhold from directors individually, committee members or the entire board (except new nominees, who are considered on a case-by-case basis) if the provisions materially diminish shareholders' rights or could adversely impact shareholders, taking into account a number of factors, including the "board's track record with regard to unilateral board action on bylaw/charter amendments or other entrenchment provisions." Unless the adverse amendment is reversed or submitted to a binding shareholder vote, in subsequent years, ISS will make voting recommendations on director nominees on a case-by-case basis. With regard to unilateral adoption of any of these provisions under the proposed voting policy, ISS's current unilateral adoption policy would be applicable: unilateral adoption of a fee-shifting provision would generally be considered an "ongoing failure" under the ISS policy for unilateral adoption, and unilateral adoption of the other provisions would generally be considered "one-time failures" under the ISS policy.

Advance Notice Requirements. ISS will now recommend a vote in favor of proposals for advance notice provisions that require notification 120 days prior to the meeting, consistent with current market practice. Under the previous policy, notification could not be required earlier than 60 days prior to the meeting.

Board Refreshment (Age /Term Limits). ISS considers board refreshment to be "best implemented through an ongoing program of individual director evaluations, conducted annually, to ensure the evolving needs of the board are met and to bring in fresh perspectives, skills, and diversity as needed." However, with the growing emphasis on achieving board diversity, the issue of board refreshment mechanisms has received more attention. Accordingly, ISS is changing its policy on term limits, but will continue to recommend against age limits. According to ISS, age limits "are arbitrary, imply an impairment to ability solely due to age, and have been used in the past to remove dissenting voices from the board." Term limits can be problematic if they are poorly designed. Under the new policy, ISS will consider recommendation on term/tenure limits on a case-by-case basis, taking into account factors such as 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.

"Deadhand" Poison Pill Provisions. Generally, for directors who adopt a short-term pill without a shareholder vote, ISS recommends a vote on a case-by-case basis. However, ISS views adoption of a device like a deadhand poison pill or its variants (such as slowhand pills) as material governance failures that are "unjustifiable from a governance standpoint," and will recommend a withhold/against recommendation on directors who include the device in the company's pill. As described by ISS, a deadhand provision

ISS' Classification of Directors as Independent. There are a number of changes to this policy, but ISS identifies as the primary change the limitation of the "Executive Director" classification to officers only, excluding other employees. According to ISS, this change will not result in any vote recommendation changes under the ISS Benchmark Policy.

Gender Diversity.  ISS is removing transitional language that permitted a company that previously had not had a female director to make a commitment to add one by February 2021. Starting in February 2021, companies with no women on their boards will receive an adverse vote recommendation; the only exception will be in the event of a temporary loss of gender diversity, i.e., if there was at least one woman on the board at the previous annual meeting, and the board commits to restoring its gender diversity by the next annual meeting.

Gender Pay Gap Shareholder Proposals. ISS recommends votes on a case-by-case basis for proposals requesting reports on pay data by gender or race/ ethnicity, or reports on policies and goals to reduce any gender or race/ethnicity pay gaps, taking into account a number of factors. The policy update adds as factors to be considered the company's "disclosure regarding gender, race, or ethnicity pay gap policies or initiatives compared to its industry peers" and "local laws regarding categorization of race and/or ethnicity and definitions of ethnic and/or racial minorities." The purpose of the change was to "highlight that some legal jurisdictions do not allow companies to categorize employees by race and/or ethnicity and that definitions of ethnic and/or racial minorities differ from country to country, so a global racial and/or ethnicity statistic would not necessarily be meaningful or possible to provide."

Mandatory Arbitration Shareholder Proposals. This new policy provides that ISS will recommend a vote on a case-by-case basis on proposals requesting reports on the use of mandatory arbitration in employment-related claims, taking into account specified factors, such as whether "the company has been the subject of recent controversy, litigation, or regulatory actions related to the use of mandatory arbitration agreements on workplace claims." The number of these proposals has increased and, apparently, ISS clients have "expressed interest in a specific policy on this topic."

Sexual Harassment Shareholder Proposals. This new policy provides that ISS will recommend a vote on a case-by-case basis on proposals requesting reports on "company actions taken to strengthen policies and oversight to prevent workplace sexual harassment," or "on risks posed by a company's failure to prevent workplace sexual harassment," taking into account a number of factors, including whether "the company has been the subject of recent controversy, litigation, or regulatory actions related to workplace sexual harassment issues." This topic is high profile, and the number of these proposals has also increased. Apparently, ISS clients have also "expressed interest in a specific policy on this topic."

Virtual Meetings. This new policy relates to the format of the annual meeting. Under the new policy, ISS will generally support management proposals that allow shareholder meetings to be convened by electronic means, as long as they do not preclude in-person meetings. The policy encourages companies to disclose the circumstances under which they would convene virtual-only meetings and to allow rights and opportunities for shareholders to participate electronically comparable to those available during an in-person meeting. 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 and concerns "identified with the company's prior meeting practices." ISS recognizes that, although the pandemic has created a "compelling rationale for restricting physical meetings," there is a substantial debate about the potential long-term impact of the virtual-only format on the rights of shareholders.

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