Market Trends: Responding to Negative Voting Recommendations by Filing Additional Proxy Soliciting Materials
 

Market Trends: Responding to Negative Voting Recommendations by Filing Additional Proxy Soliciting Materials

Posted on 10-31-2017

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.

Legal Requirements

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:

  • Press releases (e.g., related to shareholder proposals, Glass Lewis, or ISS)
  • Shareholder letters and any materials (e.g., slide presentations) used in one-on-one meetings with shareholders
  • E-mails and other written materials furnished to employees that comment on the proxy solicitation or that encourage employees to vote as recommended by the board
  • Talking points or scripts used internally or provided to proxy solicitors to contact shareholders and urge them to vote
  • Transcripts of audio and video presentations, if made available for playback after the initial presentation (and any such playback should not be made available until a transcript has been filed)

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:

  • Purely oral conversations as long as they do not consist of reading from a script during calls with investors (e.g., internal talking points that are not read verbatim typically do not constitute scripts and do not need to be filed)
  • Internal briefing materials used to prepare for meetings with shareholders and proxy advisory firms
  • Internal Q&As used in response to unsolicited inquiries that address specific questions
  • Transcripts of purely oral communications that are not made available for playback

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.

Other Benefits and Considerations

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:

  • Foundation for shareholder engagement
  • Basis for investor support. Many institutional investors have their own proxy voting guidelines that they follow. Consequently, they may be persuaded by the arguments reflected in a company’s additional proxy soliciting materials. For other investors, proxy voting personnel or portfolio managers can rely on the additional proxy soliciting materials that are a part of the public record if they choose to override a proxy advisory firm’s recommendation or make their case before a proxy committee.
  • Additional information for proxy advisory firms. As discussed in greater detail below, proxy advisory firms will only take into account publicly available information (including in circumstances where a company would like a proxy advisory firm to reverse its negative voting recommendation). Additional soliciting materials (which is how the annual meeting-related information is typically relayed once the proxy statement is filed) are effectively a prerequisite for getting proxy advisory firms to consider additional information for purposes of changing their voting recommendations.

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.

Preparing Effective Additional Proxy Soliciting Materials

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:

  • A letter, either to shareholders or a proxy advisory firm (e.g., Allstate Corp.’s DEFA14A, filed April 11, 2011; Allergan plc’s DEFA14A, filed April 19, 2016)
  • A presentation (e.g., Morgan Stanley’s DEFA14A, filed April 27, 2016)
  • Talking points (e.g., Johnson Controls International plc’s DEFA14A, filed February 22, 2011)

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?

Say-on-Pay Proposals

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:

  • Pay-for-performance relationship (i.e., arguing that the executive compensation is in line with the company’s financial performance)
  • Peer group comparators
  • Proxy advisor methodology (i.e., arguing that such methodology is faulty or does not take into account an important factor in the company’s case)
  • Factual errors
  • Timing of grants (i.e., arguing that the equity awards received during the year in which performance suffered were for performance for the prior year even though SEC rules require disclosure of equity grants in the year in which grants have been made)
  • Governance highlights (i.e., highlighting a company’s other good governance practices in addition to responding to specific executive compensation-related issues identified by a proxy advisory firm)
  • Realizable pay (defined under ISS guidelines as including the cash and benefit values actually paid, and the value of any amounts realized (i.e., exercised or earned due to satisfaction of performance goals) from incentive grants made during a specified measurement period, based on their value as of the end of the measurement period)
  • Program changes following proxy advisory firm’s recommendation

Other Issues

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:

  • Provide extra details, while highlighting the positives. The parameters of this strategy would depend, in part, on when additional proxy soliciting materials are filed. If they are filed after a negative voting recommendation is received, the company might choose to focus on one or two specific issues. If they are filed before the negative voting recommendation is received, the company might take a different approach and tell its story by emphasizing certain aspects of its compensation program and governance practices. In either case, additional proxy soliciting materials that emphasize the positives seem to be more effective than those that focus solely on refuting the proxy advisory firms’ criticisms.
  • Keep the narrative simple. As noted above, many additional proxy soliciting materials take the form of a letter or presentation. These should not be overly complicated or long. Investors are already getting tired of looking at extensive proxy statements, which is why it is important to keep the narrative simple and focused.
  • Leverage split recommendations or other third-party information. To the extent that a company receives a split voting recommendation and decides to file additional proxy soliciting materials, it may help the company’s argument to discuss the fact that another proxy advisory firm issued a different voting recommendation. References to other third-party resources could be effective as well. For instance, if a company is opposing a political contributions proposal, but has a good score in the CPA-Zicklin Index (which benchmarks the political disclosure and accountability of public corporations), that could be an important fact to highlight.

How to Reverse Negative Voting Recommendations

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

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 usresearch@issgovernance.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:

  • In limited circumstances, consider reaching out to ISS. If the reasons for a negative voting recommendation are not entirely clear, a company may want to reach out to ISS to discuss the rationale underlying the negative vote recommendation. While these discussions might be helpful in determining whether a change in company practices or policies might cause ISS to reverse its negative recommendation, having such discussions in the midst of the proxy season may not always be possible. Once the proxy statement is filed, ISS analysts have discretion as to whether engagement with the company is necessary or appropriate, and they generally only engage with companies to clarify points on which they have questions. Moreover, ISS will not, in most cases, reverse a recommendation based solely on a conversation with the company because ISS bases its decisions on publicly available information. As such, reaching out to ISS before additional proxy soliciting materials are filed should be done only in limited circumstances.
  • Determine whether any changes to company practices or policies are feasible or desirable. If it appears that a negative voting recommendation might be reversed if a company takes particular steps or adopts certain modifications, consider whether doing so would be appropriate for the company. For instance, if negative voting recommendations are based on company practice (e.g., the company has gross-ups), it may be simpler, and/or better from a governance perspective, to change the objectionable practices. Importantly, some changes will require more board involvement than others. When assessing whether to make any changes, companies should also consider tax rules (if, for example, they are amending employment agreements) and solicitation rules (if, for example, they are amending an equity plan that is up for approval at the annual meeting), among other things. Because ISS does not believe that company commitments to make changes in the future are relevant to its recommendations, ISS will, in most cases, only consider changes that a company will make immediately.
  • If changes are made, publicly disclose these changes. Any such changes should be communicated to shareholders by filing additional proxy materials on Form DEFA14A (or a combination of both Form 8-K and DEFA14A). Under the SEC rules, companies are not, in most circumstances, required to mail these supplemental materials to their shareholders. For a company that is not an SEC filer, a press release will be sufficient. Note that, as mentioned above, ISS generally will not change its voting recommendations within five business days of the company’s annual meeting. Therefore, any corrective action should be taken by the company (and any additional soliciting materials should be filed) as soon as possible after the receipt of a negative voting recommendation.
  • Promptly notify ISS. According to ISS’s website, ISS does not review all documents as they are filed on the SEC’s website. Once the changes are disclosed publicly through an SEC filing, companies should notify ISS and send it a link to the filing. If the company discloses the changes and communicates them to ISS at least five business days before the company’s meeting, and if ISS determines that this new publicly available information warrants an update to its analysis consistent with its policy, ISS will issue a reversal of the earlier negative vote recommendation through a proxy alert. Any new information received less than five business days before the meeting will be discussed in an informational alert only if it is deemed to be material to the analysis, even if there is no change to ISS’s voting recommendations.

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.

  • Contact top shareholders. Even though ISS will alert investors to a corrective report, companies should not rely on investors seeing the revised report, especially if it is expected to be a tight vote. Therefore, companies should alert their top shareholders themselves that a recommendation has been reversed.
    Moreover, conducting outreach through calls or meetings with the voting personnel at the top institutional investors to make them aware of the additional soliciting materials might be helpful even if ISS does not ultimately reverse its voting recommendation.

Glass Lewis

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.

Governance

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.

Director Elections

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.

Accounting-Related Issues

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.

Market Outlook

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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