Last week, ISS released for public comment a number of proposed voting policy changes to be applied for shareholder meetings taking place on or after February 1, 2021. The proposed changes for U.S. companies relate to board racial/ethnic diversity, director accountability for governance failures related to environmental or social issues and shareholder litigation rights, i.e., exclusive forum provisions. Comments may be submitted on the proposals through October 26, 2020.
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.” According to a summer 2020 ISS survey, 61% of
“investors indicated that boards should aim to reflect the company’s customer base and the broader societies in which they operate by including directors drawn from racial and ethnic minority groups…. Support of shareholder proposals on topics of workplace diversity disclosure and targets, and ‘Rooney rule’ type shareholder proposals were the second and third most popular actions supported by both investors and non-investors responding. In addition to these options, 56 percent of investors responded that they would also consider voting against members of the nominating committee (or other directors) where board racial and ethnic diversity is lacking.”
Accordingly, ISS is proposing, for companies in the Russell 3000 or S&P 1500 index, effective for meetings on or after February 1, 2022, to 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 racial and/or ethnic diverse member.” For 2021, the absence of racial/ethnic diversity (or the absence of disclosure of same) will not be a factor in voting recommendations, but ISS will highlight the absence in ISS research reports “to help investors identify companies with which to engage and…foster dialogue between investors and issuers on this topic.” As of September 21, 2020, ISS data indicated that “1,260 of the Russell 3000 companies, 492 of the S&P 1500 and 71 of the S&P 500 do not have minority ethnic and/or racial board representation.”
New California legislation, AB 979, should work in tandem with the new ISS voting policy if adopted. 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.
Director accountability for governance failures. Currently, ISS voting policy provides that ISS would 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. ISS is proposing to add to that list of failures “demonstrably poor risk oversight of environmental and social issues, including climate change.”
It appears that the policy is intended for directors of companies in “highly impactful sector[s]” that are “not taking steps to reduce environmental and social risks that are likely to have a large negative impact on future company operations.” In those cases, ISS would have the flexibility to find that directors of those companies “have failed in their risk oversight role if they have neglected to take meaningful steps to increase the resilience of companies to climate-related risks. The clarification is expected to impact a small number of directors each year.”
ISS notes that, historically, its approach to this issue has been retrospective, but asks for comment on whether the criteria should allow ISS “to proactively identify boards that fail to prepare for foreseeable future risks.”
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 proposed new voting policy, ISS would 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.”
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.” 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.”
Under the proposed 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,” 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 proposed new policy, ISS would recommend a “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.”
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.”
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. 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. ISS expects the impact of the proposed policy change to be limited.
Fee-shifting provisions in the charter or bylaws require that a shareholder who sues a company unsuccessfully 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., in cases where the plaintiffs are partially successful). The proposal does not change this policy, except to the extent that it accounts for the possibility that the provision could be in charters as well as bylaws.
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, 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.
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 (described above) 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 a “one-time failure” under the ISS policy.