Category Corporate Governance

On September 18, 2018, ISS announced the results of its 2018 Governance Principles Survey. ISS received responses from 638 different organizations, and includes the responses from 109 “investors.”

The Policy Survey questions focuses on:

• Auditors and Audit Committees
• Director Accountability and Track Records
• Gender Diversity on Boards
• One-Share, One-Vote Principle

Auditors and Audit Committees

ISS had asked what audit-related factors respondents considered in evaluating the independence and performance of external auditors. Significant for investors were regulatory fines or other penalties on the auditor for weaknesses or errors in audit practices. This was followed by significant audit controversies and then by the identity of the audit partner and any links he or she has to the company or management.

For non-investors, the most significant factors were: identity of the audit partner and any links e or she had to the company or its management; regulatory fines or other penalties on the company related to financial disclosure practices or weaknesses not identified in the audit report; and, regulatory fines or other penalties on the auditor for weaknesses or errors in audit practices.

The survey also asked what information shareholders should consider when evaluating a company’s audit committee. For investors the information included: skills and experience of audit committee members; significant financial reporting or audit controversies; and, the quality of the company’s financial reporting. For non-investors, the information included: skills and experience of audit committee members; quality of the company’s financial reporting; and, significant financial reporting or audit controversies.

Director Accountability and Track Records

The survey asks if a director failed in his or her boardroom oversight responsibilities at one company and this has resulted in a negative ISS vote recommendation, would it be considered appropriate and useful to note this information in the proxy research report of other companies where that director serves on the board. A significant number of investors (84%) indicated that such information would be useful to know and see on the ISS proxy reports. Only 41% of the non-investors indicated that such information would be helpful to see.

The survey then asked what types of oversight shortfalls would be relevant. Investor and non-investor responses were generally aligned and indicated that the most significant was risk oversight failures relating to fraud or other forms of corporate malfeasance.

When asked what would be an appropriate look-back period for such oversight shortfalls, investors indicated a longer time period (30% 5 years and 39% no time limit), while non-investors favored a shorter time period (44% 3 years, 13% 1 year).

Gender Diversity on Boards

In its 2017 Policy Survey, ISS asked if it was problematic if there were no female directors on a public company board. This year, ISS asked the same question to gauge year-over-year changes, if any.

80% of investors (up from 69% in 2017) thought it would be problematic. Among non-investors, over 60% indicated it would be problematic (compared to 54% in 2017). Of those Investors who thought it problematic, the most appropriate response was to engage with the board and/or management on the issue.

One-Share, One-Vote Principle

The survey asked if ISS should provide vote results where possible to show what the vote results would have been if all votes were counted equally. 92% of investors and 59% of non-investors responded in favor of this.

The survey also asked if ISS should use adjusted vote results to measure board responsiveness to shareholder votes. Investors were largely in favor (72%), but non-investors were split (42% thought it appropriate and 46% did not).

The survey also asked about an appropriate timeframe for sunset provisions on unequal voting rights. 46% of both investors and non-investors picked either “1 to 3 years” or “4 to 6 years.”

ISS Announcement with Link to 2018 Policy Survey Results

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Early this week ISS opened up its annual policy survey, the results of which will influence the new ISS policies and changes to existing policies for the 2019 proxy season (i.e., impacting shareholder meetings on or after February 1, 2019). Today, we will look a bit closer at the two surveys that ISS launched: the 2019 Governance Principles Survey, and the 2019 Policy Application Survey.

2019 Governance Principles Survey

There are five issues ISS is seeking input in on this survey:

• Auditor Independence: What factors should be considered in addition to non-audit services and fees as a percentage of total fees when evaluating independence of auditors?
• Audit Committee: What factors are important in evaluating the effectiveness of the Audit Committee?
• Director Accountability: Is it relevant for ISS to examine directors’ controversies on other boards when evaluating directors? If so, what would be relevant and what length of look-back period should be used?
• Board Gender Diversity: ISS here is repeating questions it asked last year on gender diversity to gauge whether it is concerning if there are no female directors on a board?
• One-Share, One-Vote Principle: Should ISS adjust vote results to show the results if all shares had equal voting rights? If so, should these adjusted results inform ISS’s board responsiveness review? What is the appropriate time period for a sunset provision on unequal voting rights?

2019 Policy Application Survey

The questions in this survey applicable to the U.S. are:

• Independent Chair: What factors are important when ISS determines its vote recommendation with respect to a shareholder proposal for an independent chair?
• Minimum Stock Ownership Requirements for Bylaw Amendments: Asks what the minimum ownership thresholds above the required SEC Rule 14a-8’s $2,000 stock holding requirement should be, and should multiple shareholder be able to aggregate holding to meet such threshold?
• Quantitative Pay-for-Performance Screens: ISS is considering supplementing or replacing the four (4) GAAP financial metrics used in its P4P analysis with Economic Value Added (EVA) for purposes of the Financial Performance Assessment. ISS is asking if the survey participant supports the use of EVA in the P4P analysis, and, if so, how it should be incorporated.
• Non-employee Director Pay: In 2018 ISS identified non-employee director (NED) pay outliers and will begin to recommend against compensation committees where elevated NED pay persists over multiple years without compelling justification. ISS is asking survey participants what should constitute a compelling justification.
• Board Qualifications Matrix: The New York City Pension Funds has advocated for the disclosure of a director matrix to help shareholders assess director fit and the mix of skills among all directors. ISS is asking survey participants what level of disclosure on directors skills they find most useful.

For links to these ISS surveys, please see my prior post:

ISS Releases Global Policy Survey

Survey Closing Times

• 2019 ISS Governance Principles Survey closes on August 24, 2018 at 5 pm Eastern, and the
• 2019 ISS Policy Application Survey closes on September 21, 2018 at 5 pm Eastern.

This week, the new Democrat SEC Commissioner, Robert J. Jackson, Jr., gave a speech in which he presented the findings of his staff’s research into how “buybacks  affect how much skin executives keep in the game.” Commissioner Jackson was a law professor who liked to conduct research before joining the SEC. Commissioner Jackson said that he often asked his students two questions when thinking about how to give corporate managers incentives to create sustainable long-term value:

• Are we making sure that executive pay gives managers reason to invest in the long-term development of their workforce and their communities?
• Or are we paying executives to pursue short-term stock-price spikes rather than long-term growth?

Commissioner Jackson noted that the theory behind paying executives in stock is to give them incentives to create long-term sustainable value. But, as he also pointed out, that only works when executives are required to hold the stock over the long term.

So when the Tax Cuts and Job Act was signed into law, Commissioner Jackson worried that we would see a repeat of what corporations did when the last corporate tax holiday was enacted in 2004–use the cash influx for stock buybacks and not necessarily  invest in long-term value creation. The first quarter of 2018 saw corporations buyback $178 billion in stock. So Commissioner Jackson and his staff studied 385 buybacks over the last 15 months and matched them to information on executive stock sales. They found:

• A buyback announcement leads to a big jump in stock price–typically more than 2.5% during the 30-days after the announcement;
• In half the buybacks studied, at least one executive sold shares in the month following the buyback announcement.
• In the days before a buyback announcement, executives trade in relatively small amounts (less than $100,000 worth daily), but during the 8 days following a buyback announcement, executives on average sell more than $500,000 worth of stock each day.

Commissioner Jackson did acknowledge that this stock trading by executives is not necessarily illegal. However, he finds it troubling as he see it as more evidence that executives are spending more time on short-term stock trading than long-term value creation.

Commissioner Jackson pointed out that, “Executives often claim that a buyback is the right long-term strategy for the company, and they’re not always wrong. But if that’s the case, they should want to hold the stock over the long run, not cash out once a buyback is announced. If corporate managers believe that buybacks are best for the company, its workers, and its community, they should put their money where their mouth is.”

Commissioner Jackson then called for the SEC to update its rules to limit executives from using stock buybacks to cash out from America’s companies. He also called for an open comment period to reexamine the SEC’s rules in this area to make sure they protect employees, investors, and communities given today’s unprecedented volume of buybacks.

Implications

At the very least, any company that has undertaken a stock buyback during the past 1 to 2 years, should know how their executives traded stock shortly after the announcement of their buyback. Companies should know which executives made these stock sales and the rationale for the sales. Companies should be prepared to answer questions about such transactions from their investors and the media. It also might be a good idea to review whether peers undertook stock buybacks during the past 1-2 years and how much stock was sold by their executives shortly after their buybacks were announced. Companies should review this data and know how they compare to their peers, and, if relevant, larger market players. Companies contemplating adopting a stock buyback should consider this emerging view as an additional point in their deliberations.

Executives should ensure that they are utilizing a Rule 10b5-1 stock trading plan, and have established such a plan when they do not have any material non-public information (such as the fact that the company is considering adopting a stock buyback plan). While a Rule 10b5-1 plan does not offer full protection to executives, it is the best currently available to protect them from allegations of illegal stock trading, assuming the plan is set up as required by the rule. If stock sales were made after a buyback announcement that did not utilize a Rule 10b5-1 plan, executives should ensure that all preclearance procedures were followed. To the extent that stock sales increased after a buyback announcement, executives should review the reason for such action and be prepared to discuss with their Boards or internal compliance officer.

Link to SEC Commissioner Jackson’s Speech

https://www.sec.gov/news/speech/speech-jackson-061118

On November 13, 2017, ISS opened the data verification window for its QualityScore.  The data submission window will remain open until 8 pm Eastern on November 28. The data submission for both QualityScore and peer groups is doen through ISS’s Governance Analytics database, so a working user login is required for companies to make these submissions.

ISS at the same time released an updated technical document on QualityScore that details the factors that go into it, available at:

http://images.info.isscorporatesolutions.com/Web/ISSCorporate/%7Bec72720c-4c60-4f81-a5e6-ddf60de12b0c%7D_qualityscore-techdoc-13112017.pdf