ISS Releases Benchmark Policy Updates for 2021

On November 12, 2020, Institutional Shareholder Services (“ISS”) announced updates to its 2021 benchmark voting policies.  The key ISS voting policy updates for U.S. companies relate to (1) the racial/ethnic diversity of the board of directors and (2) shareholder litigation rights related to exclusive forum proposals.  ISS has also updated certain other existing voting policies as described below.  The updates are effective for shareholder meetings on or after February 1, 2021, except for the policy regarding racial/ethnic board diversity, which has a one-year transition period.  ISS’ executive summary is available here, and the Americas policy updates are available here.

Racial/Ethnic Board Diversity

ISS has not previously had a voting policy regarding board racial or ethnic diversity but noted that “recent social unrest has put racial and ethnic injustices and inequalities at the forefront of many investors’ minds and many boards’ deliberations.”  ISS also noted that many investors had expressed interest in seeing increased ethnic or racial diversity on boards, citing reasons of equality and good corporate governance.  ISS does not define what qualifies as racial or ethnic diversity.  However, earlier this year ISS sent letters to public companies asking them to voluntarily disclose information on the self-identified race/ethnicity of each of the company’s directors and named executive officers.  The letter allowed each director or officer to disclose up to three classifications from multiple categories, largely drawn from the OMB Standards for the Classification of Race and Ethnicity.  ISS does not specify how it will identify racial and/or ethnic diversity, but it is possible that ISS may provide further guidance on this topic in the future.

• In 2021, ISS will not use any lack of racial and/or ethnic diversity on a company’s board of directors as a factor in its vote recommendations on directors.  However, for companies in the Russell 3000 or S&P 1500 indexes, ISS will identify in its research reports whether there is a lack of racial and/or ethnic diversity on the board of directors to help investors identify companies with which to engage and foster dialogue between investors and companies on this topic.
• For meetings on or after February 1, 2022 held by companies in the Russell 3000 or S&P 1500 indexes, ISS will recommend an against or withhold vote from the chair of the nominating committee (or other directors on a case-by-case basis) where the board of directors has no apparent racially or ethnically diverse members.  Aggregate diversity statistics provided by the board will only be considered if they are specific as to racial and/or ethnic diversity.  ISS will make an exception 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. 

Exclusive Forum Proposals

ISS’ current voting policy provides for a case-by-case analysis of bylaws that impact shareholders’ litigation rights.  Under the new policy, ISS generally supports exclusive forum provisions but differentiates between provisions for federal securities law claims and state corporate law claims.  ISS also clarifies that unilateral adoption by the company’s board of directors of certain provisions is considered a one-time failure under its unilateral bylaw/charter amendments policy.  Under ISS’ unilateral policy, 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.

ISS’ new voting policy on exclusive forum provisions follows a March 2020 ruling by the Delaware Supreme Court in Salzberg v. Sciabacucchi that forum selection clauses in corporate charters are facially valid, reversing a decision by the Delaware Court of Chancery and resulting in some companies incorporating such provisions into their governing documents.  This necessitated a new ISS policy on these new voting items and provided ISS an opportunity to re-examine the existing policy on exclusive forum provisions for state law matters. 

ISS observed that federal forum selection provisions seen to date generally require only that federal securities litigation be brought in the district courts of the United States and generally do not specify a particular federal district.  ISS noted that without the argument that an exclusive forum provision for federal law cases would seriously inconvenience plaintiffs, the benefits of eliminating duplicative litigation and ensuring that cases are heard by courts that are well-versed in the applicable law carry greater weight.  In contrast, when evaluating proposals to establish the state of incorporation as the exclusive forum for cases arising under state corporate law, shareholders must balance the advantages, such as potential cost savings and eliminating risks of unpredictable or incorrect outcomes, against the disadvantages, such as inconvenience to plaintiffs who must bring suit in another state and hire local counsel.  Notwithstanding this, ISS also recognized that Delaware corporations designating Delaware as the exclusive forum for corporate law disputes can benefit from a greater likelihood of a speedy and efficient resolution due to Delaware’s separate court system specializing in corporate law cases and its large body of precedent.

Based on these considerations, ISS made the following changes to its shareholder litigation rights voting policy regarding exclusive forum provisions:

• Federal Forum Selection Provisions:

• ISS will generally recommend for a proposal to amend the company’s charter or bylaws to adopt a federal forum selection provision if the federal forum provision specifies “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.
• ISS will recommend against a proposal to amend the company’s charter or bylaws to adopt a federal forum provision if the provision restricts the forum to a particular federal district court.
• ISS will generally consider unilateral adoption of a federal forum provision that restricts the forum to a particular federal district court to be a one-time failure under its unilateral policy, resulting in a recommended 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). 

• Exclusive Forum Provisions for State Law Matters: 

• ISS will generally recommend for a proposal to amend the company’s charter or bylaws to adopt a forum selection provision that specifies 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.
• ISS will vote case-by-case on proposals to amend the company’s charter or bylaws to adopt a forum selection provision that specifies a state of incorporation other than Delaware as the exclusive forum for corporate law matters.  ISS will consider factors including the stated rationale for adopting such a provision, past harm from duplicative lawsuits, the types of lawsuits to which the provision would apply and governance features, such as the ability to repeal the provision and to hold directors accountable through elections.
• ISS will generally recommend against a proposal to amend the company’s charter or bylaws to adopt a forum selection provision that specifies a state other than the state of incorporation as the exclusive forum for corporate law matters.
• ISS will generally consider unilateral adoption of a forum selection provision that specifies a state other than the state of incorporation as the exclusive forum for corporate law matters to be a one-time failure under its unilateral policy, resulting in a recommended 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).

Other Policy Updates

Other significant voting policy updates issued by ISS include the following:

Governance Failures:  Material Environmental & Social Risk Oversight Failures.  Under extraordinary circumstances, ISS will hold individual directors, committee members or the whole board accountable when the company has governance failures due to the board’s material failure to oversee risk.  ISS has updated its voting policy to add “demonstrably poor risk oversight of environmental or social issues, including climate change” as an example of a material failure to oversee risk. 

Board Composition -- Gender Diversity.  During the 2020 proxy season, ISS provided a transition period for the board gender diversity policy originally adopted in 2019, which provided that a company that previously had not had a female director could make a commitment to add one by the following year.  Now that the transitional year has passed, ISS has removed this transitional policy.  ISS’ new voting policy provides that the only instance in which it will grant an exception to an adverse vote recommendation for nominating committee chairs (or other directors, on a case-by-case basis) at Russell 3000 or S&P 1500 companies where no women serve on the board is if a company had at least one female director at the previous annual meeting (but no longer does) and the board commits to restoring its gender diversity by the next annual meeting.

Board Independence -- Classification of Directors.  ISS also made certain changes to its classification of directors under its board independence voting policy.  The primary change was to limit the classification of an “Executive Director” to officers only and not other employees of the company, such as those on the board as employee representatives.  ISS has reclassified these employee directors as a “Non-Independent Non-Executive Director.”  Accordingly, this change will not result in any vote recommendation changes under ISS’ voting policy, but it will result in a more accurate assessment of a director’s executive positions for purposes of certain institutional investor overboarding policies.

Board Accountability -- Poison Pills.  Recently in response to pandemic-related market volatility, several short-term poison pills have been adopted that include a deadhand feature.  A deadhand provision restricts the board’s ability to redeem or terminate a poison pill as it can only be redeemed if approved by a board consisting of a majority of continuing directors.  ISS views such provisions, as well as slowhand provisions that apply the redemption restriction only for a period of time (e.g., 180 days), as “unjustifiable from a governance standpoint” because they are intended to thwart the will of shareholders that voted to replace the board in order to enable an offer to proceed.  Under its new voting policy, ISS will therefore recommend against or withhold from all nominees (except new nominees, who are considered on a case-by-case basis) if, among other things, the board adopts a poison pill (whether short-term or long-term) that has a deadhand or slowhand feature.  If a poison pill including such a feature is enacted but expires before the next shareholder vote, ISS will generally still recommend withhold or against director nominees at the next shareholder meeting following its adoption.

Board Refreshment (Age/Term Limits).  ISS recognizes that companies are increasingly imposing age or tenure limits as mechanisms for board refreshment.  ISS is generally opposed to these types of board refreshment efforts, but has updated its voting policy to soften its stance against term limits.  Under its new voting policy, ISS will vote case-by-case on management proposals that limit the tenure of directors through term limits, looking for well-designed tenure policies that do not enforce too short a term limit and thereby allow a range of director tenures to provide a balance of experience with new perspectives.  For shareholder proposals seeking term/tenure limits, ISS will vote case-by-case considering the scope of the proposal and evidence of problematic issues at the company related to a lack of board refreshment.

Advance Notice Requirements for Shareholder Proposals/Nominations.  To align with market practice, under ISS’ new voting policy, ISS will now view as reasonable advance notice provisions that provide for a window for shareholder notice of action (via director nomination or other business) 120 days prior to the anniversary of the previous year’s meeting and a submittal window of no shorter than 30 days (i.e., a 90-120 day window).  Previously, ISS would recommend a vote against advance notice proposals that included a deadline for shareholder notice of a proposal/nomination that was more than 60 days prior to the meeting.  This policy is not meant to apply to Rule 14a-8 proposals or director nominations via proxy access.

In addition to the voting policy updates described above, ISS also issued updates related to gender or race/ethnicity pay gap shareholder proposals, mandatory arbitration shareholder proposals, sexual harassment shareholder proposals and management proposals to allow for virtual shareholder meetings.

Upcoming Key ISS Dates

ISS has also publicly shared some key upcoming dates for the 2021 proxy season.  Below is a list of key dates:

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. John-Paul Motley, an O’Melveny Partner licensed to practice law in California, Shelly Heyduk, an O’Melveny Partner licensed to practice law in California, and Su Lian Lu, an O’Melveny Senior Counsel licensed to practice law in California and New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.