Institutional Shareholder Services (ISS) announced benchmark voting policy changes in the United States, increasing expectations for board racial and ethnic diversity, adding director accountability for environmental and social failures and clarifying its position on forum selection provisions included in a company’s governance documents. The revised policies, which were announced on November 12, 2020, will generally apply to shareholder meetings held on or after February 1, 2021. The most significant of these policy changes are described below.
Considering recent social unrest related to racial and ethnic inequalities and acknowledging that many investors support racial and ethnic diversity on boards, ISS adopted a new policy related to board racial and ethnic diversity, which provides that for companies in the Russell 3000 or S&P 1500 index, effective for meetings on or after February 1, 2022, ISS will generally recommend a vote “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 racially or ethnically diverse members. Mitigating factors include the presence of a racial and/or ethnic minority on the board at the preceding annual meeting and a firm commitment to appoint at least one racially and/or ethnically diverse board member.
Like ISS’s approach to gender diversity, the policy provides for a one-year transition period for implementation. For the 2021 proxy season, ISS will only highlight a company’s lack of racial/ethnic board diversity in its report and will not use it as grounds to oppose the election of directors. However, for the 2022 proxy season, ISS will generally recommend voting “against” or “withholding” from the chair of the nominating committee (or other directors on a case-by-case basis) absent any mitigating factors noted above.
For public companies headquartered in California, the timing for this policy’s implementation will coincide with the requirements of recently adopted California law, AB 979, that requires such companies to have at least one director from an underrepresented community by the end of 2021. AB 979 defines “director from an underrepresented community” to include individuals who self-identify as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian or Alaska Native, or gay, lesbian, bisexual or transgender. For a discussion of AB 979, see our previous article here.
Unlike AB 979 (which still has some ambiguities), ISS’s policy does not offer specific categories regarding the kind of racial/ethnic diversity that would satisfy its policy, nor does it address representation from the LGBT community. This lack of specificity may give companies that are not subject to AB 979 more flexibility in satisfying the ISS racial/ethnic board diversity policy, though, at the same time, there is increased risk that ISS may disagree with categorization in specific cases.
While there is no existing public disclosure standard for disclosure of a board’s racial or ethnic diversity, ISS had already begun an outreach program directly to public companies affirmatively asking them to provide the specific self-identified race/ethnicity of each of their directors and named executive officers. This direct outreach program is likely to form the basis for ISS’s application of this policy (see our prior coverage of those efforts here). In addition, certain institutional investors are requesting that companies voluntarily disclose the racial/ethnic and gender composition of their boards of directors in their proxy statements for 2021 and are contemplating adopting policies to vote against nominating committees of boards with no racial/ethnic diversity.1
Board Oversight: Material Environmental and Social Risk
ISS has added specific language identifying “demonstrably poor risk oversight of environmental and social issues, including climate change” to its list of examples of material risk oversight failures by a board that would result in a recommendation of “against” or “withhold” for directors, committee members or the whole board. This follows ISS’s 2020 global policy survey, where 75% of investors agreed with the statement that it is appropriate to consider a vote against directors who are deemed to be responsible for poor climate change risk management oversight. ISS is expected to aim this change at companies in sectors facing more environmental and social risks where the failure to address such risks would negatively impact future operations. While ISS anticipates that this policy change will affect a small number of directors each year, it does not indicate nor provide examples of what would constitute “poor risk oversight of environmental and social issues.” As companies respond to pressure from shareholders and other stakeholders to increase disclosure on environmental and social issues, they should bear in mind the potential impact of such environmental, social and corporate governance (ESG) disclosure, including litigation risk associated with such disclosure. It is unclear whether a poor ESG ranking based on proxy statement or other company disclosure would be enough for ISS to determine that the board has failed to exercise sufficient oversight of environmental and social issues.
Exclusive Forum Provisions
Federal Forum Selection Provisions
The Delaware Supreme Court’s decision in Salzberg v. Blue Apron Holdings2 and resulting inclusion of (or re-activation of) federal forum provisions (FFP) in many company charters and bylaws have provided ISS with an opportunity to revise its Litigation Rights policy to address forum selection provision proposals. The new ISS policy on FFPs is to:
- Generally recommend a vote for FFPs in the charter or bylaws that specify "the district courts of the United States" as the exclusive forum for federal securities law matters.
- Generally recommend a vote against FFPs that restrict the forum to a particular federal district court.
ISS reasoned that because most FFPs do not require that litigation take place in a particular federal district court, shareholder plaintiffs would not be too inconvenienced by such provisions. Furthermore, the benefits of avoiding duplicative litigation and having cases decided by courts that are experienced in federal securities law would outweigh any inconvenience caused by an FFP. Unilateral adoption (without a shareholder vote) of an FFP that violates this policy will generally still be considered a one-time failure under the Unilateral Bylaw/Charter Amendments policy, which may result in ISS recommending votes “against” or “withhold” votes for directors at only a company’s next annual meeting.
Exclusive Forum Provisions for State Law Matters
The new policy recommends that shareholders should generally vote for charter or bylaw provisions that specify Delaware, or the Delaware Court of Chancery, 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 focused specifically on Delaware given its prominence as the state of incorporation for many U.S. companies and its well-developed body of corporate case law. ISS believes that these factors would allow for the efficient resolution of cases involving Delaware corporate law.
For exclusive forum provisions involving states other than Delaware, ISS recommends voting on a case-by-case basis taking into account:
- The company's stated rationale for adopting such a provision,
- Disclosure of past harm from duplicative shareholder lawsuits in more than one forum,
- The breadth of application of the charter or bylaw provision, including the types of lawsuits to which it would apply and the definition of key terms, and
- Governance features such as shareholders' ability to repeal the provision in the future (including the vote standard applied when shareholders attempt to amend the charter or bylaws) and their ability to hold directors accountable through annual director elections and a majority vote standard in uncontested elections.
However, the policy states that shareholders should generally vote against provisions that specify a state other than the state of incorporation as the exclusive forum for corporate law matters, or that specify a particular local court within the state. Unilateral adoption of such a provision will generally be considered a one-time failure under the Unilateral Bylaw/Charter Amendments policy, which may result in ISS recommending “against” or “withhold” votes for directors at only a company’s next annual meeting.
Fee Shifting Provisions
Finally, ISS has clarified that its prior policy against fee-shifting applies to such provisions contained in charters as well as bylaws. Its proposed change defines fee-shifting as provisions in the charter or bylaws that require a shareholder who sues a company unsuccessfully to pay all litigation expenses of the defendant corporation and its directors and officers. The proposed change also specifies that if a board unilaterally adopts fee-shifting provisions it would generally be considered an ongoing failure (unlike the forum selection policies) under ISS’s Unilateral Bylaw/Charter Amendments policy resulting in votes against board members at each subsequent annual meeting until the company removes such provisions.
Virtual Shareholder Meetings
As a result of the COVID-19 global pandemic, a substantial majority of companies held virtual-only shareholder meetings for the first time in 2020. Many companies will be considering whether to continue with the virtual-only meeting format, return to the traditional physical meeting or adopt a “hybrid” meeting approach.
Given the general success of virtual-only meetings in 2020, the use of virtual meetings is widely expected to be a popular preference of companies going forward. Some investors have expressed concern about the potential impact of a shift to virtual-only meetings on shareholders’ ability to engage with management. Others have noted that virtual meetings allow significantly more shareholders to participate in annual meetings by reducing the cost and time burden of attending.
ISS has adopted a new policy to generally recommend a vote for management proposals allowing for the convening of shareholder meetings by electronic means, so long as they do not preclude in-person meetings. Companies are encouraged to disclose the rationale for and circumstances under which virtual-only meetings would be held, and to allow for comparable rights and opportunities for shareholders to participate electronically as they would have during an in-person meeting. In addition, the policy establishes a case-by-case approach on shareholder proposals on virtual-only meetings.
With the increase in shareholder proposals regarding social issues such as human capital management, ISS has also taken the opportunity to clarify and adopt new policies regarding shareholder proposals requesting reports on various workplace-related issues. ISS has clarified its existing policy requiring a case-by-case analysis for proposals seeking gender, race or ethnicity pay gap data or policies to acknowledge that some jurisdictions do not allow companies to categorize employees by race and/or ethnicity, so some statistics may not be meaningful or possible. In addition, ISS has adopted new policies recommending that shareholders vote on a case-by-case basis for proposals seeking reports on the use of mandatory arbitration for employment-related claims and actions taken to prevent risks posed by workplace sexual harassment. For both mandatory arbitration and workplace sexual harassment proposals, ISS will take into account the company’s current policies and practices, whether the company has been subject to recent public controversy, litigation or regulatory action and its disclosure relative to its peers. ISS adopted these policies because of the increased support that they have received from shareholders recently noting that several went to a vote in 2019 and 2020.
Practical Advice to Companies
In response to the policy changes described above, we advise that companies do the following:
- Thoughtfully approach the solicitation of racial/ethnic self-identity, including explaining the form in which such information may be disclosed. In consultation with advisors, the board of directors should determine the best way to gather this potentially sensitive information.
- Consider expanding disclosure in the company’s 2021 proxy statement to provide specific information on racial/ ethnic board diversity. Those that already have self-identified racial or ethnic diversity should disclose such information on at least an aggregate basis to meet the increasing demands of investors and to avoid ISS scrutiny (or on an individual basis if consistent with the company’s culture and the expectations for board members). Companies that do not currently have a racially or ethnically diverse board should include discussion of their plans for achieving it (counsel should carefully review any such disclosure).
- To the extent that racial/ethnic diversity will be included in the proxy statement or other public securities filings, establish appropriate disclosure controls and procedures in connection with the recording, aggregation and disclosure of such sensitive information.
- Be prepared to address the gender, LGBT, racial and ethnic makeup of the board as well as the company’s diversity plans and efforts during shareholder engagement discussions.
- Pay attention to potential ESG-related risks and how they are disclosed. Consistent with the broader focus on ESG issues by investors (of which diversity and inclusion are a part), ISS may recommend against a company’s board members based on perceived environmental and social risks. Companies should be prepared to engage with investors on environmental and social risks that may negatively impact their operations and should strive to understand and report on the key ESG metrics by which their investors will measure them.
- If adopting or amending a charter or bylaws to include an exclusive forum provision, ensure that it complies with the new policies noted above to avoid adverse ISS recommendations for the election of board members.
- Since directors of companies with fee‑shifting provisions could continue to receive negative ISS recommendations each year until repealed, such companies should consider whether removing the provision is advisable in their circumstances.
- Consider carefully before deciding to proceed with virtual-only meetings on a going forward basis, and if a virtual-only meeting is desired, ensure that adequate disclosure is included in the proxy statement regarding why a virtual-only meeting is appropriate, and how investors will be able to meaningfully engage with the company’s management and board in such a meeting.
1. Press Release, “Illinois State Treasurer Frerichs Calls on Russell 3000 Companies to Disclose Board Diversity Data,” (October 28, 2020). ↩
2. In Salzberg v. Blue Apron Holdings, Inc. [Sciabacucchi], No. 346, 2019 (Del. Mar. 18, 2020), the court held that a federal forum provision was facially valid under DGCL § 102(b)(1). For a discussion of that case and the first case in California upholding a federal forum provision, see our prior articles here and here.↩