Wednesday, October 31, 2012

Corporate Secretaries Society Has Concerns with ISS Policy on Board Response to Majority-Approved Shareholder Proposals

The Society of Corporate Secretaries and Governance Professionals has major concerns with a proposed revision to the Institutional Shareholder Services (ISS) voting policies on a board’s response to a majority-supported shareholder proposal. In a letter to the ISS Global Policy Board, the Society said that the proposed change would undermine the exercise of directors’ fiduciary duties on matters that under state law are firmly within the board’s purview. The Society urged the Global Policy Board to reject this proposed change.

Currently, ISS policy provides for opposition to all incumbent directors if the board does not act on a shareholder proposal that was supported by a majority of outstanding shares the previous year, or a majority of shares cast the previous year and at least once in the two years before that. The revised policy would accelerate this process, with against or withhold recommendations on all but new directors if the board does not act on a shareholder proposal between the annual meeting and the publication of the proxy statement for the next annual meeting, whether the shareholder proposal received a majority of votes outstanding or a majority of votes cast.

In the Society’s view, this shortened time frame for a board to take action in instances where a proposal is supported by a majority of the votes cast, rather than a majority of the outstanding shares, raises significant concerns about the coercive nature of the director vote and its impact on the ability of directors to perform their fiduciary obligations.

The Society noted that fiduciary duties do not disappear or become less significant when a majority of the votes cast at a meeting support a particular non-binding shareholder proposal.  A fundamental principle of state corporation law is that directors are not mere agents of shareholders but must exercise their independent judgment to act in the best interest of the corporation.  Thus, boards of directors cannot implement a proposal presented to shareholders that they do not believe would be in the best interests of a company. Rather, they must determine the most appropriate response to the proposal, which may be to consider other actions they believe address the shareholder concerns in a manner consistent with the best interests of the corporation. 

The Society believes that in these circumstances the appropriate policy approach would be to consider disclosure of board action with respect to alternatives considered, any action taken and the board’s rationale for its decision.  An automatic recommendation against all directors is inappropriate and inadvisable. The group also said that the importance of the shareholder proposal in question, and the importance of other factors in the election of directors, is not being given due consideration in the proposed policy change. 

There is a risk that an entire board under a majority vote framework will be removed for failure to set special meeting rights at a 10 percent threshold rather than 15 percent.  If the director vote matters, reasoned the Society, making it contingent entirely on one, possibly minor, difference does not serve the interests of the company or the shareholders.

Moreover, in view of the number of companies that have adopted majority voting for directors and eliminated staggered board elections, an ISS negative vote recommendation could result in the failure to elect a board.  According to the Society, a strict one-size-fits-all policy that leads to this result without any consideration of the broader circumstances, including the positive value that a board brings on other matters and the level of importance of the particular subject matter of the proposal, cannot be in the interest of the shareholders.

The Society is also concerned that the policy is based on a majority of shares voted, not on a majority of shares outstanding, and does not take into account whether the proposal was approved under the company’s own rules. The expression of substantial opposition to the ISS view, by for example 49 percent of shares voted, apparently is seen as meriting no consideration by a board, where a compromise on an issue may make more sense.  This is in stark contrast to the ISS policy on say-on-pay, in which substantial opposition by a minority of shares voted is said by ISS to require a response from the board.  A board should have some flexibility to take into consideration substantial minority views.

In addition, the revised policy is silent on the circumstances under which ISS would view a board as having failed to act on a majority-supported shareholder proposal.  It would thus appear that, under this policy change, ISS would be second-guessing board decisions to implement a proposal in an alternative manner, even where the alternative approach is submitted for shareholder approval.  The Society believes that this is fundamentally at odds with a board’s fiduciary duties under state corporate law.

For example, a board may respond to a proposal to permit shareholders to act by written
consent by reducing the ownership threshold at which shareholders can call a special meeting. In this instance, the Society queries if ISS would call for a vote against all directors. While ISS previously has not recommended against directors in some cases like this, the change in policy would appear to yield a different result.