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By: Lori Zyskowski GIBSON, DUNN & CRUTCHER LLP
The voting recommendations of proxy advisory firms—including, most notably, Institutional Shareholder Services (ISS) and Glass Lewis & Co. (Glass Lewis)—continue to influence the voting outcomes of company and shareholder proposals. Even when the company’s largest shareholders follow their own voting policies, the voting recommendations of proxy advisory firms can be influential on the voting outcome.
WHEN FACED WITH A NEGATIVE VOTING RECOMMENDATION, to the extent the recommendation is not based on an error that can easily be corrected, most companies elect to file additional proxy soliciting materials along with engaging directly with shareholders to explain their side of the story or to potentially address the underlying issue that led to a negative vote recommendation. This article principally explores the practice (and effectiveness) of responding to negative vote recommendations from proxy advisory firms by filing additional definitive proxy soliciting materials with the Securities and Exchange Commission (SEC). As discussed in greater detail below, a decision whether to file additional proxy soliciting materials is specific to each company’s individual circumstances. In addition, in an era of sharpened focus on shareholder engagement, some companies file additional proxy soliciting materials in connection with their annual shareholder meetings as part of their ongoing shareholder engagement strategy. Given these trends, companies will continue to file additional proxy soliciting materials, both regularly as part of their annual proxy solicitation process, and on special occasions, such as when they seek to respond to a negative voting recommendation from one or more proxy advisory firms.
When faced with a negative voting recommendation on a company proposal or one or more director nominees, companies typically want to convince their shareholders that voting in line with the board’s recommendations is appropriate. However, shareholder outreach while a proxy solicitation is being conducted must be carefully managed to avoid violating the SEC’s proxy solicitation rules. Specifically, under Section 14(a) (15 U.S.C. § 78n) of the Securities Exchange Act of 1934, as amended, and Rule 14a-6 (17 C.F.R. § 240.14a-6), public companies are required to file any “soliciting” materials that could be deemed to be “written” communications related to the matters to be voted on at the annual meeting. As such, the primary benefit of filing additional soliciting materials is to facilitate shareholder outreach by allowing companies to communicate directly with shareholders about their proposals while complying with proxy solicitation rules.
What Must Be Filed?
The SEC’s rules define solicitation broadly; the definition includes “[t]he furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement . . . of a proxy.” Therefore, companies should generally file any written communications or materials given to shareholders (whether by mail, e-mail, or in one-on-one meetings) and other groups (if designed to influence the vote) related to the proxy statement or matters to be voted on at the annual meeting. Examples include:
Filing additional soliciting materials is relatively simple as it involves only an SEC Schedule 14A cover page plus whatever soliciting materials will be used or distributed. They appear in the SEC’s EDGAR electronic filing system as DEFA14A filings.
Importantly, in addition to the SEC’s solicitation rules, companies should also keep in mind Regulation FD (17 C.F.R. § 243.100–103) (which prohibits selective disclosure of material, nonpublic information to a shareholder under circumstances in which it is reasonably foreseeable that the shareholder will purchase or sell the company’s securities on the basis of that information) and Rule 14a-9 (17 C.F.R. § 240.14a-9) (which prohibits making materially false and misleading statements in connection with proxy solicitations). As such, all levels of the company should be urged to involve the legal department in all possible meeting-related communications to assess possible filing requirements.
What is the Timing of Filing Additional Soliciting Materials?
Filings are due at the same time communications are sent or provided to shareholders. The release and filing of written materials (e.g., press releases, web postings, or shareholder letters) therefore needs to be coordinated.
What Does Not Need to Be Filed?
Even though soliciting material is broadly interpreted, the following are typically not required to be filed under SEC rules:
In addition, no filing is typically required if the company is providing information that is within the four corners of what has been previously publicly filed by the company. As such, the company may consider filing a broad set of talking points or other additional soliciting materials relatively early on in the process. Such materials may help minimize the number of subsequent supplemental filings.
What Are Some Other Benefits of Filing Additional Proxy Soliciting Materials in Response to Negative Voting Recommendations?
In addition to complying with the legal requirements, additional proxy soliciting materials can be useful for a variety of other reasons, including:
Should a Company Always File Additional Proxy Soliciting Materials in Response to a Negative Voting Recommendation?
The various proxy advisory firms have different approaches for evaluating company and shareholder proposals. As a result, it is not uncommon for companies to get a favorable recommendation from one advisory firm, while receiving a negative recommendation from another. In addressing such split recommendations, companies need to understand the makeup of their shareholder base and recognize that ISS recommendations may carry more weight with investors than recommendations from Glass Lewis or other proxy advisory firms because ISS is more widely followed. If a company receives a favorable recommendation from ISS and a negative recommendation from Glass Lewis or another proxy advisory firm, the company may not find it advisable to openly address the negative recommendation by filing additional proxy soliciting materials with the SEC, especially because doing so could draw more attention to the negative recommendation than would otherwise be the case. In evaluating whether additional soliciting materials might be warranted, a company should consult with its proxy solicitor to determine how many of its major shareholders follow the voting recommendations of a particular proxy advisory firm. To the extent that such shareholder base is not significant, the company may determine that it is better to wait to address the issues in the company’s next proxy statement.
What Do Additional Soliciting Materials Filed in Response to Negative Voting Recommendations Typically Look Like?
Additional soliciting materials filed in response to a negative voting recommendation can take various forms. The most common formats include:
While less common, they can also take a form of website pages, e-mail correspondence, and scripts.
What Do Additional Proxy Soliciting Materials Filed in Response to Negative Voting Recommendations Typically Address?
Semler Brossy, an executive compensation consulting firm, has been tracking additional proxy soliciting materials filed in response to negative say-on-pay recommendations from proxy advisory firms since 2011. The number of such additional proxy soliciting materials has declined substantially since 2011, even though the percentage of companies receiving a negative voting recommendation from ISS has remained relatively constant (12% in 2016 and 12.5% in 2011). This is likely because Semler Brossy’s data also indicates that company responses via additional proxy soliciting materials to a negative voting recommendation do not have a material impact on voting results. Moreover, while a say-on-pay vote is by no means routine, most companies are now familiar with the voting methodologies of proxy advisory firms when it comes to sayon-pay proposals and generally understand how to approach their say-on-pay votes in both good and bad years.
According to Semler Brossy, only 35 additional proxy soliciting materials responding to a negative say-on-pay voting recommendation were filed in 2016 (as compared to 59 in 2011 and 113 in 2012). Such materials typically address the following key topics, with pay-for-performance being addressed in more than 70% of such additional soliciting materials in each year since 2011:
Outside of the say-on-pay space, to the extent additional soliciting materials are meant to address a specific issue (such as a bylaw amendment or disclosure around material internal control weaknesses), they tend to be relatively limited in scope to the topic in question. For instance, additional soliciting materials that are intended to disclose that a non-independent director (under the proxy advisory firm’s standards) has resigned from the public company’s key committees might be limited to one sentence disclosing precisely that. Such additional soliciting materials are simple and to the point.
If the issue is more complex (such as a proxy advisory firm supporting a shareholder proposal that could impact the company’s leadership structure or require the company to incorporate in a different state), a company may choose to include a more detailed explanation of why shareholders should vote in line with the board’s recommendations, as opposed to recommendations of a proxy advisory firm. Typically, such additional soliciting materials would also highlight the company’s good governance practices in addition to addressing the subject or issue that led to a negative voting recommendation.
What Additional Proxy Soliciting Materials Are the Most Effective?
To the extent additional soliciting materials address more complex topics (such as say-on-pay proposals), it is better to counter the proxy advisory firms’ arguments through the careful presentation of countervailing evidence and/or a compelling story rather than by openly criticizing the proxy advisory firms and their proxy voting practices or guidelines. At a high level, the most effective additional proxy soliciting materials that are not meant to address specific/simple issues do the following:
Can a Negative Voting Recommendation Be Reversed?
In order to ensure consistency, the proxy advisory firms’ policies are generally inflexible by necessity. That means that it is not easy to get a proxy advisory firm to reverse its voting recommendation once it is public, even with the most well-written additional proxy soliciting materials. However, this does not mean that doing so is impossible. In all cases, companies should focus their efforts on reaching their shareholders. In other words, even if additional soliciting materials are not sufficient to sway a proxy advisory firm, they may be sufficient to sway enough of the institutional investors who have more flexible voting policies and do not uniformly vote with the recommendations of the proxy advisory firms.
ISS generally issues U.S. company proxy reports 13 to 25 calendar days before the shareholders meeting. In the United States, companies in the S&P 500 can elect to receive a draft of their ISS report for fact-checking purposes before it is distributed to ISS’s clients. Therefore, an S&P 500 company should review its draft report and notify ISS of any inaccuracies or other comments by e-mail at email@example.com. Similarly, other companies should contact ISS as soon as possible after the final report is issued if any errors are found. All companies can access ISS’s proxy analyses of their company without charge through an ISS governance analytics platform (for which companies must obtain log-in information in advance). Once the report is final, if ISS agrees there is an error, it will issue a proxy alert to its clients. Companies are more successful in receiving revised recommendations when they can demonstrate that ISS made an irrefutable factual error (for example, where the ISS recommendation is based on the assumption that the compensation plan has single-trigger acceleration for vesting of outstanding awards, when, in fact, it has double-trigger acceleration).
Notably, it is critical that companies address inaccuracies promptly because ISS generally will not change its voting recommendations within five business days of the company’s annual meeting. New information received within the five business days before the meeting will be set forth in an informational alert if ISS determines it is material to the proxy analysis but will not result in a revised voting recommendation. ISS will issue an alert to change a voting recommendation closer than five business days before the meeting only under “highly extraordinary circumstances.”
Outside of an objectively verifiable error (that can and must be proved by referring to publicly available proxy materials), it is difficult to get ISS to reverse its voting recommendation, although it is still possible. Outlined below are typical considerations and steps for a company that is seeking to have ISS reverse its voting recommendation:
ISS distributes the proxy alert to the same clients that received the original proxy report. It is typically overlaid on top of the original proxy report so that the original report, the updated information, and any vote recommendation change are contained in one document. Note that, according to the ISS’s website, there may be circumstances, such as “egregious actions,” where ISS would refuse to change its voting recommendation even if the company were to take the steps to cure the issues ISS identified in its report.
Glass Lewis asks companies to notify them online (http://www. glasslewis.com/report-error/) if there is an error in a Glass Lewis proxy paper report. The submission should include (1) details on the issue, including meeting date, proposal number and title, page number in the report, and the full sentence in which the discrepancy appears; and (2) information as to precisely where within the company’s public disclosure Glass Lewis can find and verify the correct information to revise its report. As with ISS, Glass Lewis bases its analysis strictly on publicly available information. If a company updates its proxy materials or notifies Glass Lewis of a purported factual error/ omission, Glass Lewis will consider whether a revision to the report is appropriate. If Glass Lewis agrees that a revision to the report is appropriate, Glass Lewis will update its report to reflect new disclosure or the correction of an error. The revised report will explain the nature of all revisions in a note in the report and notify clients via e-mail of the revised report, regardless of whether the update or revision affected Glass Lewis and/or clients’ custom recommendations.
Glass Lewis typically will not discuss its policies or recommendations with issuers during the solicitation period (which begins on the date the notice of meeting is released and ends on the date of the meeting). However, Glass Lewis is willing to meet with companies during the solicitation period, if necessary, to discuss purported errors or omissions in its reports. In addition, if one of its analysts needs a clarification on a particular issue, Glass Lewis will contact the company or accept a request for a call during the solicitation period as long as the discussion is confined to publicly available information.
While it is rare for Glass Lewis to overturn a negative recommendation, if there is enough time before the meeting and the circumstances warrant a change under its voting policy, Glass Lewis may be willing to reverse a negative recommendation.
Another area where companies frequently receive negative ISS recommendations is governance. Sometimes these recommendations are with respect to governance proposals; at other times, they are with respect to director elections, including the governance committee chair and/or other members of the board. For instance, in 2016 ISS recommended that shareholders withhold votes from the only member of one company’s governance committee who was up for reelection that year. This was due to the company’s decision to bundle two charter amendments (to declassify the board and to elect directors by majority vote) into a single voting item at its annual meeting and its proposed adoption of a majority vote standard for directors that did not include a provision for plurality voting in contested elections.
In subsequently filed additional soliciting materials, the company revised the proposal to amend its charter to require plurality voting in contested elections and to include a director resignation policy. ISS found this to be sufficient to mitigate shareholders’ concerns and reversed its voting recommendation with respect to the governance committee member.
One of the most unpleasant situations a company sometimes has to deal with is receiving a negative voting recommendation with respect to one or more of its directors because the company did not realize that ISS would consider the director to be either on too many public boards or not independent under ISS guidelines (which, in some cases, are stricter than applicable listing exchange independence standards). However, depending on the director’s and the company’s circumstances, this, too, can be remedied.
For instance, one company had a director who was determined by the board to be independent under the New York Stock Exchange Listing Standards and who served on its nominating and corporate governance committee. ISS, however, determined that the director was not independent under its standards due to his former employment (more than three years before the proxy filing but within the previous five years) with what later became a subsidiary of the company.
After the company filed additional proxy soliciting materials disclosing that the director resigned from the nominating and governance committee, ISS reversed its recommendation with respect to this director.
One of the easiest issues for a company to address is a lack of adequate disclosure. This can arise when a company discloses a material weakness in its internal controls. ISS has a specific policy that says that it will recommend votes against, or withhold votes from, members of the audit committee, and potentially the full board, if there are material weaknesses in internal controls identified in Sarbanes-Oxley Section 404 (15 U.S.C. § 7262) disclosures. ISS will examine “the severity, breadth, chronological sequence and duration, as well as the company’s efforts at remediation or corrective actions, in determining whether withhold/against votes are warranted.”
In one case, the company disclosed a material weakness in the previous two years and received a negative voting recommendation from ISS with respect to the company’s audit committee members. ISS specifically noted that the material weakness had persisted for two audit cycles and had not been remediated. The company filed additional proxy soliciting materials that detailed steps taken by its audit committee to remediate the material weakness and enhance internal controls, including that (1) three of the four material weaknesses had been remediated, while the fourth was in the process of being remediated; (2) the company needed additional time to be able to confirm that a sustainable, controlled process was fully in place; and (3) the company expected to complete the planned remedial actions during the then-current fiscal year. ISS deemed this information to be sufficient and reversed its voting recommendation.
Although additional proxy soliciting materials will remain an important tool for companies responding to negative voting recommendations, shareholder engagement is expected to remain the real driver for filing additional soliciting materials. Filing additional soliciting materials shortly after a proxy statement is filed (even before proxy advisory firms release their voting recommendations) provides more time for companies to have conversations with their shareholders and for shareholders to conduct and complete whatever internal approvals are necessary to finalize their votes. Additional soliciting materials can be effective tools in shareholder engagement and in discussing a company’s perspectives on a variety of issues or concerns that shareholders and proxy advisory firms may have. Given the importance of shareholder engagement and the ways that filing additional soliciting materials can facilitate engagement, additional soliciting materials are expected to continue to be an important part of responding to a negative voting recommendation.
Lori Zyskowski is a partner in Gibson Dunn’s New York office and a member of the Firm’s Securities Regulation and Corporate Governance Practice Group. Ms. Zyskowski advises public companies and their boards of directors on corporate governance matters, securities disclosure and compliance issues, executive compensation practices, cybersecurity oversight, and shareholder engagement and activism matters. Ms. Zyskowski is a frequent speaker on governance, proxy, and securities disclosure panels and is very active in the corporate governance community. She is a member of the board of directors of the Society for Corporate Governance and served as Secretary to the board from 2011 to 2013.
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RESEARCH PATH: Capital Markets & Corporate Governance > Market Trends > Corporate Governance & Continuous Disclosure > Practice Notes
For additional information on proxy advisory firms, see
> UNDERSTANDING THE ROLE OF PROXY ADVISORY FIRMS
RESEARCH PATH: Capital Markets & Corporate Governance > Proxy Statement and Annual Meeting > Mailing and Delivery of the Proxy Statement > Practice Notes
For further information on proxy solicitation and the contents of an annual report, see
> DRAFTING THE PROXY STATEMENT AND ANNUAL REPORT
RESEARCH PATH: Corporate Counsel > Shareholder, Board and Company Actions > Proxy Statements and Annual Meetings > Practice Notes
For a set of guidelines and questions to consider for a policy with respect to shareholder engagement and communications, see
> BOARD ENGAGEMENT WITH SHAREHOLDERS POLICY CHECKLIST
RESEARCH PATH: Capital Markets & Corporate Governance > Corporate Governance and Compliance Requirements for Public Companies > Corporate Governance > Checklists
For an overview on say-on-pay votes, see
> COMPLYING WITH DODD-FRANK’S SAY-ON-PAY PROVISIONS
RESEARCH PATH: Capital Markets & Corporate Governance > Executive Compensation > Corporate Governance Issues > Practice Notes
For an outline on how companies can prepare themselves for proxy voting recommendations from Institutional Shareholder Services (ISS), see
> PREPARING FOR ISS PROXY VOTING RECOMMENDATIONS CHECKLIST
RESEARCH PATH: Capital Markets & Corporate Governance > Proxy Statement and Annual Meeting > Shareholder Activism > Checklists
For guidance on how a company may exclude a shareholder proposal from its proxy materials, see
> EXCLUDING SHAREHOLDER PROPOSALS AND SEEKING NO-ACTION LETTERS
RESEARCH PATH: Capital Markets & Corporate Governance > Proxy Statement and Annual Meeting > Shareholder Activism > Practice Notes
For a detailed discussion on the distribution of proxy materials, see
> MANAGING THE MAILING AND DELIVERY PROCESS FOR PROXY MATERIALS